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Risks of Investing in Callable Securities
Premium callables trade at “yield to call”—meaning that the price of the bond is calculated with the assumption that the bond will be called—and carry extension risk. If interest rates rise before the end of the lockout period, the bond’s embedded option becomes worth less, as the security is less likely to be called. Discount callables trade like bullets—non-callable bonds—to maturity and carry compression risk. If interest rates fall, they become more likely to be called. Callable securities that are at the money—where interest rates are very close to the point where the option will be exercised—have the most sensitivity to changes in market rates and implied volatility.

Investment Strategies Using Callable Securities
Many investors use callable securities within a total return strategy—with a focus on capital gains as well as income—as opposed to a buy and hold strategy focused on income and preservation of principal.
Owners of callable securities are expressing the implicit view that yields will remain relatively stable, enabling the investor to capture the yield spread over noncallable securities of similar duration. They must also have views on the likely range of rates over the investment period and the market’s perception of future rate uncertainty at the horizon date for reasons explained in Risks of Investing in Callable Securities above. If an investor has the view that rates may well be volatile in either direction over the near term but are likely to remain in a definable range over the next year, an investment in callable securities can significantly enhance returns.
http://www.investinginbonds.com/learnmore.asp?catid=5&su...

Obviously, I’ve been called on yet another holding, this time my position in Penn VA’s 10.350’s of ’16, and I'm merely doing my post-transaction due-diligence by taking a refresher look at the professional literature.

Here's the details of the trade. I got in a price that gave a projected YTM of 9.3%. I’m getting kicked out at an achieved YTC of 10.6%. The 130 basis point difference could be considered the premium I earned for accepting call-risk. I buy a lot of callable bonds, and I have found over the years --as the article above describes-- that the gig can be profitable.

Charlie
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Standard Disclaimers: The technique described in the quoted article and my comments is not suitable for all investors. Consult with a financial professional before attempting to use it for your own account, so you can blame him or her when you screw up, which is most likely what will happen, because learning how to invest effectively takes more consistency and disciple than most people bring to the task. They want the profits that investing can provide, but they aren't willing to do the necessary work, but nonetheless continue to be surprised by their failure and resentful of the success of others.

These feelings are particularly endemic in American culture where equality of results is legislated far more than equality of opportunity. Markets aren't subject to those laws. They provide neither equal access, nor equal results. But they are far more a meritocracy than any other institution an ordinary citizen has access to. If you're disciplined and capable, you will make money. If you aren't, you will lose it, and you can have no one to blame but yourself. You create your profits. You create your losses, not your broker, not your adviser, not the newsletter subscription you bought, not the discussion forum post you might have read (but probably misunderstood). Your results are wholly dependent on your own efforts, discipline, and abilities.
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Thanks for all the informative posts.

I buy a lot of callable bonds, and I have found over the years that the gig can be profitable.

Over the years, since 1981, we have had declining interest rates, and now we have the Fed’s Zero Interest Rate Policy (ZIRP). The longer ZIRP lasts, the more I would expect that companies will try to call back their high interest bonds and replace with low interest rate bonds or pay off their loans or find other forms of financing.

Maybe this time it’s different? Won't your gig become more difficult or less profitable?
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Stu,

If buying callable bonds were my only tactic, then, "Yes", I'd be facing headwinds. But, in fact, the situation is far, far worse. No matter the strategy, no matter the tactics, all investors and traders are screwed by the Fed's shenanigans. What any of us are doing right now amounts to rearranging deck chairs on the Titanic. That's a tired, over-used metaphor that makes it no less true. 2008-2009 was merely the mildest, most normal of corrections compared to what lies ahead. Most investors will see 60% to 80% of their present value wiped out. So, yeah, I'm having fun right now making the fat returns I am. But I know full well all of them will come under attack and that much of them will disappear. We're in asset bubble driven by the Fed's decades-long, accommodative monetary policies. Every penny of those ill-gotten gains will be reversed, and then a whole bunch more, because markets always over-correct. http://www.portfolioprobe.com/2011/06/17/bubble-anatomy/bubb...

So, what am I doing to protect present wealth? Taking money of the table and rewriting my investment plan, in which a lot more emphasis with be placed on 'hedging' than 'speculating', both of which are concepts poorly understood (much less used effectively) by the so-called 'average investor' who reads little and thinks even less. But for those who do want to get ahead of the tsunami, work your way through Taleb's books and technical papers. His proposed escape path is the only viable one.

Charlie
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