Skip to main content
Message Font: Serif | Sans-Serif
 
No. of Recommendations: 6
I think your analysis is largely correct. The risks to the scenario you've outlined are:

- A drop in PRS ratings which would make the original 7% coupon $25 issue price bond overpriced and permanently drop the price of the bond below $25. You can buy a 6% yield bond from BAC (IKR) so the question is how much riskier is PRS. If it's not that much riskier then the 7% yield is appropriate and the price will trickle back up toward $25. If it is and the 9% yield is more appropriate (I doubt that) then the price won't move too much and PRS has no need to call the issue before maturity.

- If interest rates rise the price will likely not come near $25 and PRS, again, has little reason to call the bond.

- If interest rates are lower four years from now when PRS can first call the bond then the company will call the bond at $25. But, anticipating this call, the bond price will rise to close to $25. (For those who find this confusing, the reason PRS would call the bond at that time is b/c it has little reason to continue borrowing from the public at 7% when it can do so at 6%. That is, the company can call this bond that pays $1.75 annually for $25 and instead issue a bond that pays, say, $1.50 per $25 -- the exact numbers depend on the interest rate).

It strikes me that investing in PRD is a less volatile way of investing into PRS. The key pressures on the debt seem to have been:

- concern that the underlying company that issued the debt is riskier than previously thought;

- a quick exit by a large institutional holder (given that this was a top investment of some of the hedge funds that got into trouble with subprime it is possible that they had to raise capital quickly from positions that they liked very much)

It appears that both of these are temporary. If that is the case, PRD represents just the kind of scenario that you described: a chance at 30% or so price appreciation along with about a 9% interest payment (keep in mind that these are interest payments and are taxed at a rate higher than dividends).
Print the post  

Announcements

What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.