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Hi all,

Sorry if these questions are a bit elementary to many of you, but I am just beginning to learn about the bond market, and it's a little confusing.

I understand the basics - you can buy various types of government bonds from Treasury. However, I don't quite understand the different types. For example, why does an EE bond have a different yield from an I bond? And both of these are different from the 2, 10, and 30 year bonds.

Also, I don't understand what the "bond market" is, exactly. I often see in articles that the 10 year lost 18/32 with the yield rising to 4.31%. How does the yield change every day?

I'm sure that there is a FAQ document somewhere, but I haven't found it. Any help that you can offer here would be much appreciated. Thanks much!

paigerella
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No need to apologize: we all started at the same place, and unfortunately the occasional, "we ought to do an FAQ," doesn't mean we do it.

I recommend the Vanguard web site as a good, straight forward, place to learn about bonds and bond funds.

A few specific answers to you questions:

US Savings Bonds (I-bonds, EE bonds) are different from Treasury bonds. You buy them from the treasury department and cash them in—they aren't traded. Both I and EE savings bonds have vaiable interest rates, reset twice a year. EE rates are set at 90% of the average yield of 5-year (traded) treasury bonds. I-bonds are sold at a fixed rate (for the 30 year life of the bond, or until you cash in) plus (or minus) an inflation component, based on the last 6 months' CPI (if there is deflation, this is subtracted from the fixed rate, but cannot go below zero, so your previously accumulated interest is safe). So, EE and I bonds have different interest rates because one is based on the treasury bond market, the other on fixed rate plus inflation. In principle, given past history of 5 year (tradable) treasuries, over the long run a fixed rate on I-bonds of around 2.5% would end with the same results as EE bonds. However, in its wisdom, the treasury has decided to play around with the fixed rate (from my cynic's point of view, at first they set it too high as a kind of loss-leader to attract customers, then when treasuries were trading at historically very low rates above the CPI, they set the fixed rate too low).

Treasury Bonds (2, 5, 10, historically 30 year, short term) are initially sold by the treasury in auctions (to finance the deficit). They then trade on the open market, much like stocks. The actual interest paid by the treasury on these bonds (the "coupon") doesn't change, but the price paid for the bond does, so the yield changes inversely to the price of the bond (on days when bond values go up, yields go down, and vice versa). The bond market is basically traders deciding how much they are willing to pay (based on whether they or their clients are doing more buying and selling). But US Savings bonds (I and EE) are not part of this buying and selling, even though EE bond interest rates are set based on interest rates set by trading.
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I work at a bank and i would have to double check with one of the personal bankers but here is my understanding about EE and I bonds.

The EE bond has a lower yield then the I bond because you buy it for half of its face value. So if the bond is worth $100 you only pay $50 for it. It takes about 17 years for it to double in value though.

The I bond, you buy it at its face value. So if you want to buy a $100 I bond you will have to pay $100 for it.

In order to avoid paying a fee you cannot cash both bonds in until after a year. If you cash the bonds in before a year you are charge a 3 month interest rate fee. So in my opinion its just a matter of how long you invest your money. I always thought the interest rate for both bonds were not fixed, but lokicious said they were so i would have to double check with a banker when i go to work.

Oh you can only buy a max of $30,000 worth of bond per social security number a year. The federal reserve called and told me that one time when one of our customers bought over the limit. Save us the paper work and hassle and dont buy more then 30,000:). If you do want to invest more then 30,000, just have your spouse buy 30,000 also and put your name as co-owner. Also the website is www.treasurydirect.gov, there is a nice bond calculator there to play around with. I'll check with the fix yield on the I bond and get back to you.
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" I work at a bank and i would have to double check with one of the personal bankers but here is my understanding about EE and I bonds.
The EE bond has a lower yield then the I bond because you buy it for half of its face value. So if the bond is worth $100 you only pay $50 for it. It takes about 17 years for it to double in value though.
The I bond, you buy it at its face value. So if you want to buy a $100 I bond you will have to pay $100 for it."

The "face value" issue has nothing to do with the yield on EE vs I bonds. It is true you buy EE bonds at half their "face value," but this is fairly meaningless. It is simply that an EE bond is guaranteed to double within a certain time (recently changed to 20 years from 17 years): in practice, the interest earned has always led to it doubling in less than that time. What really matters is how much money you invest up-front: if you buy a $5000 I-bond for $5000 or an EE bond with a $10000 face value, you are still putting down $5000, and it is that $5000, plus compounding, that is earning interest.

"In order to avoid paying a fee you cannot cash both bonds in until after a year. If you cash the bonds in before a year you are charge a 3 month interest rate fee. So in my opinion its just a matter of how long you invest your money. I always thought the interest rate for both bonds were not fixed, but lokicious said they were so i would have to double check with a banker when i go to work."

Both I bonds and EE bonds have variable interest rates, changed semi-annually. However, the I-bond has a fixed rate component, with the variation coming from adjustments to the inflation rate, while for the EE bond the entire interest rate varies according to the trading value of the 5-year treasury bond. This is why, when we see a fixed rate component on the I bond of 1.1% (current rate), we can be pretty sure over the long run, EE bonds will do better, because 5-year treasuries have historically traded well more over inflation than 1.1%.
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we can be pretty sure over the long run, EE bonds will do better, because 5-year treasuries have historically traded well more over inflation than 1.1%.
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Does anyone have a chart on this?

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GADawg,

Best I can do for the moment is link you to a previous discussion of this topic:

http://boards.fool.com/Message.asp?mid=18851380

(You can get to the whole thread from their, but Acme's comment is most useful).

We did at one point have a link to an academic paper that did simulations of what fixed rate for an I-bond would likely beat an EE bond, but the link has disappeared, like so many old links. Maybe Acme can provide more details (again) on his own investigation.

Bottom line from both the paper and Acme's research was a fixed rate above 2.5% makes I bonds the clear choice, below 2.25% makes EE bonds the clear choice, and between, is statstical error (.e., flip a coin, or do mix and match).

Even if we do go into an extended period where 5-year treasuries are trading at an historically low rate above inflation, the current I-bond 1.1% is way, way low. Even when 5 year treasuries were recently very low (because of deflation fears, investors fleeing stocks and chasing bond returns, war panic, traders piling on, etc.), 5-year treasuries were still over 1% above the core inflation rate, even at their lowest.
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The EE bond has a lower yield then the I bond because you buy it for half of its face value.

That has nothing to do with it. A lot of people are speculating that EE-Bonds will have higher yeilds than I-Bonds at the November announcement of new rates because the CPI-U component of I-Bonds is likely to be very low which, when "added" to the fixed rate component of the currently-issued I-Bonds, will probably be below 90% of the six month average yield of 5-year Treasury Notes (what the EE-Bond rate is based on). We'll find out for sure in about five weeks. 8)

Several people have done studies using historic CPI-U values and another indicator for inflation for pre-CPI-U values to see how I-Bond yields would have done in the past, even before the I-Bond was ever issued, and looking at 90% of the yields of the 5-year Treasury Notes in the past, and have concluded that historically when the fixed rate component of I-bonds was 2.6% or higher the I-Bond was the better buy for the long term, and when the fixed-rate component of I-Bonds was under 2.25% the EE-Bond would have been a clear winner, and different people have disagreed about the 2.25% to 2.6% part. Currently I-Bonds have a fixed-rate component of only 1.10%, which, if history can serve as a long-term predictor going forward, would suggest that currently EE-Bonds are a better buy.

The current high yield of I-Bonds is because of the last announced inflation component that included a spike in inflation preceding the invation of Iraq, but the inflation component next time is expected to be very low or possibly even negative. (If it is negative, an I-Bond purchased when the fixed rate component was 1.10% would have a six-month earning period of having the annualized rate of return below 1.10%--the guarantee with I-Bonds is that the nominal return won't drop below 0%.)

So if the [EE]-bond is worth $100 you only pay $50 for it. It takes about 17 years for it to double in value though.

First, it is now 20 years when you are guaranteed that the EE-Bond will be at least double what you paid for it. Second, so far the Treasury hasn't had to do the one-time step-up of value to "face value". Third, when purchased through Treasury Direct, one doesn't have a paper bond to have any "face value" so the current wording talks of reaching twice the purchase price (issue price) by the "initial maturity" (now 20 years from date of issue) or having a one-time step-up in value. See http://www.publicdebt.treas.gov/sav/sav597ee.htm

In order to avoid paying a fee you cannot cash both bonds in until after a year. If you cash the bonds in before a year you are charge a 3 month interest rate fee.

Both I-Bonds and EE-Bonds are illiquid for the first year from month of issue--the exception is if your geographic area is declared a disaster area. If you redeem an I-Bond or EE-Bond within 5 years from month of issue, you forfeit the most recent 3 months of interest.

I always thought the interest rate for both bonds were not fixed, but lokicious said they were so i would have to double check with a banker when i go to work.

For I-Bonds and current EE-Bonds, the interest rate changes every six months from month of issue. So if you purchased an I-Bond or an EE-Bond, you are guaranteed the current interest rate only for six months.

Oh you can only buy a max of $30,000 worth of bond per social security number a year.

You can purchase up to $30,000 of paper I-Bonds plus $30,000 of "book entry" (paperless) I-Bonds plus $30,000 issue price of paper EE-Bonds (used to be $15,000 issue price = $30,000 face value) plus $30,000 of "book entry" EE-Bonds a year. See "Frequently Asked Questions about changes in the savings bond program / Purchase Limitations" at http://www.publicdebt.treas.gov/sav/sbregfaq.htm#purchase

If you do want to invest more then 30,000, just have your spouse buy 30,000 also and put your name as co-owner.

You can purchase up to $30,000 (issue price) paper EE-bonds (Savings Bonds Direct, EasySaver, through many financial institutions, etc.) plus an additional $30,000 (issue price) of "book entry" EE-Bonds through Treasury Direct per calendar year.

You can also purchase up to $30,000 of paper I-Bonds (Savings Bonds Direct, EasySaver, through many financial institutions, etc.) plus an additional $30,000 of "book entry" I-Bonds through Treasury Direct per calendar year.

That means one could purchase up to $120,000 of Savings Bonds per calendar year.

The limit is based on the first name/SSN on the registration so, like you said, to work around the limit, you can be the first name/SSN listed for your quota and your spouse could be the first name/SSN listed for your spouse's quota, which brings the conceivable limit up to $240,000/yr. The other person could be a co-owner or other designation.

The I-Bond Information page is at http://www.publicdebt.treas.gov/sav/sbiinvst.htm

The EE-Bond Information page is at http://www.publicdebt.treas.gov/sav/savinvst.htm

The Frequently Asked Questions / Changes in the Savings Bond Program is at http://www.publicdebt.treas.gov/sav/sbregfaq.htm

I think you have some reading to do. 8)
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<<
we can be pretty sure over the long run, EE bonds will do better, because 5-year treasuries have historically traded well more over inflation than 1.1%.
**********************************************************
Does anyone have a chart on this?
>>

I don't necessarily agree with the above statement because it seems to me that we are in uncharted territory these days, and as they say,“ past performance is no guarantee of future results”.

This link charts both REAL and NOMINAL rates for short (91 day) and long (30 yr) treasuries over the past 50 years. 5 year should fall in between.

http://www.martincapital.com/chart-pgs/CH_mmnry.HTM

In addition, you will notice that during the seventies (when inflation was high) real rates averaged less than zero most of the time. With I-Bonds you are guaranteed a real return in all environments (inflationary or deflationary). This added insurance should be worth something.

BTW, click on Charts and Data at this site for other interesting charts.
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the exception is if your geographic area is declared a disaster area.

Now there is something I did not know! Such declarations happen often these days (see the recent hurricain). That would present an interesting opportunity to make adjustments in your bond holdings.

Splotto
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the exception is if your geographic area is declared a disaster area.

Actually, I should have said if The Bureau of Public Debt declares your area a disaster area. See http://www.publicdebt.treas.gov/sav/savdisas.htm
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Yea i did some reading and was going to post up what i found at work but basically they are right:)
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With I-Bonds you are guaranteed a real return in all environments (inflationary or deflationary).

Well, I suppose it depends on your definition of "real return". If that includes 0% nominal during deflation, then, yes, you're guaranteed a real return in all environments. But many people wouldn't consider that a return (though clearly it's better than losing money).

As most here know, in a deflationary environment, I Bonds can return 0%. Versus deflation, that's not bad, but I think many would be confused if they read they're guaranteed a real return, but they get 0%.

Ken
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in a deflationary environment, I Bonds can return 0%.
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Series I, inflation-indexed savings bonds purchased from May through October 2003 will earn a 1.10 percent fixed rate of return above inflation. The 1.10 percent fixed rate applies for the 30-year life of I Bonds purchased during this six-month period.


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I don't necessarily agree with the above statement because it seems to me that we are in uncharted territory these days, and as they say,“ past performance is no guarantee of future results”.

"Past performance is no guarantee" is a very useful reminder, but it is important to understand what it is really saying.

Historical statistics are an effect not a cause. Just because something was statistically significant in the past does not necessary mean it will be statistically significant in the future. And, of course, singular events, such as a mutual fund outperforming the averages for an extended period, cannot be proven to be due to a cause (such as a better investment strategy) rather thanbeing a random result (just by randomness there will be a few mutual funds that outperform for an extended period).

But when we do see a statistically valid historical pattern—statisitcally valid means there is a high probability that the pattern has a cause and is not just a random result—it provides an impetus for trying to tease out the cause and see if it still exists. Actually evaluating causes (properly controlling variables) is exceedingly difficult, so in many cases, when trying to make decisions without absolute proof, we are left thinking through the overall sense of the pattern and its likelihood the continue.

For example, I have been very critical of those who are convinced small cap value stocks will outperform the rest of the stock market in the future, although they have in the past (over a long period), because they have not outperformed more recently after changes in tax law and the lesser enforcement of anti-trust laws and other factors that I think provide an advantage to big companies. Lacking a clear reason why small cap value stocks should outperform, and noting changing causes, I would dismiss the historical statistic as outdated.

With how much over inflation bonds trade, I would ask whether we can hypothesize changed circumstances that might undermine the historical pattern. What happened in the '70s? What's happening in Japan? Ultimately, bond prices are set by supply and demand, not inflation. Offhand, I can think of three big issues that could affect supply and demand with bonds over the next 10-20 years: the deficit, foreign "trust" of US government to repay loans, and baby boomers retiring and possibly shifting heavily from stocks to bonds. I'm sure there are other issues. The ones I mention contradict each other.

Although it is impossible to draw defintive conclusions, I continue to think, while bonds may return less over inflation than historically, the 1.1% currently offerred by I-bonds is not just a little below the historical average, it is way less.
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Although it is impossible to draw defintive conclusions, I continue to think, while bonds may return less over inflation than historically, the 1.1% currently offerred by I-bonds is not just a little below the historical average, it is way less.
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I-bonds currently pay 4.66%. The 1.1-% is fixed and the rest is variable depending on the CPI.
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in a deflationary environment, I Bonds can return 0%.
****************************************************
Series I, inflation-indexed savings bonds purchased from May through October 2003 will earn a 1.10 percent fixed rate of return above inflation. The 1.10 percent fixed rate applies for the 30-year life of I Bonds purchased during this six-month period.

In a deflationary environoment, I bonds can return 0%. If there were deflation of 1.1% for a 6-month period, that 1.1% would be substracted from the fixed rate. However, I-bonds cannot return less than 0% (TIPS can!), meaning you can't lose previously accumulated interest. If we had 5% deflation, the return would still be 0% for the I-bond.

A fixed rate of 1.1% is well below the historical rate by which EE bonds beat inflation (more or less 2.5%). The current inflation component is irrelevant to this point.
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KenAtPcs writes:
<<
With I-Bonds you are guaranteed a real return in all environments (inflationary or deflationary).

Well, I suppose it depends on your definition of "real return". If that includes 0% nominal during deflation, then, yes, you're guaranteed a real return in all environments. But many people wouldn't consider that a return (though clearly it's better than losing money).
>>

Yes, "real return" was referring to REAL interest rates (as opposed to NOMINAL), since that was the subject of my post.

For clarity sake, then let me rephrase my statement:

With I-Bonds you are guaranteed a positive REAL interest rate return in all environments (inflationary or deflationary).
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Lokicious writes:
<< Although it is impossible to draw defintive conclusions, I continue to think, while bonds may return less over inflation than historically, the 1.1% currently offerred by I-bonds is not just a little below the historical average, it is way less.
>>

I agree with your last post, other than the last 4 words of your conclusion. ("it is way less").

Here are my reasons:
Investment valuations change over time. Some examples are:
1) During the first half of the century, investors expected equity dividend yields to be greater than bond yields but that later reversed.
2) Before the 1970s investors could count on the equity earnings yield to drop below the long bond yield near market bottoms. Benjamin Graham used this as a buy signal. This does not seem to happen anymore.

I also think that the "2.5% EE bond historical rate" that you quote might be a bit high.
I come to this conclusion because according to the Martin Capital chart, the 50 year average REAL return for 30-year treasuries is 2.51%. Now if EE bonds were based on the 30 year bond then we would average (.9 x 2.51) = 2.26%. So I have to conclude that an average based on the 5 year bond would be somewhat lower.

Presently 5 year REAL rates are below their historical norm. Who knows if and when they will return to the mean.
So taking the 1.1% I bond with the added inflation protection seems like a viable alternative.
Sort of like choosing a "a bird in the hand" rather than "2 in the bushes"

That said, I have bought both I bonds and EE bonds this year, and I'm prepared to cash either if they become uncompetitive at my 1 year aniversery. I believe in hedging my bets.
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in a deflationary environment, I Bonds can return 0%.
****************************************************
"Series I, inflation-indexed savings bonds purchased from May through October 2003 will earn a 1.10 percent fixed rate of return above inflation. The 1.10 percent fixed rate applies for the 30-year life of I Bonds purchased during this six-month period."

I should have added:
http://www.publicdebt.treas.gov/com/comi0503.htm
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in a deflationary environment, I Bonds can return 0%.
****************************************************
"Series I, inflation-indexed savings bonds purchased from May through October 2003 will earn a 1.10 percent fixed rate of return above inflation. The 1.10 percent fixed rate applies for the 30-year life of I Bonds purchased during this six-month period."

I should have added:
http://www.publicdebt.treas.gov/com/comi0503.htm
*************


And if inflation is -5%, do the I Bonds return 0%, which would be way more than the 1.1% above inflation (1.1%-5% = -3.5%)?
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And if inflation is -5%, do the I Bonds return 0%, which would be way more than the 1.1% above inflation (1.1%-5% = -3.5%)?

Yes. See http://www.publicdebt.treas.gov/sav/sbifaq.htm down at "5. Can I ever lose money in I Bonds?"
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in a deflationary environment, I Bonds can return 0%.

------------

How about EE bonds? Can their return go negative, or is it pegged at 0%
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How about EE bonds? Can their return go negative, or is it pegged at 0%

EE bonds have no inflation component. They are pegged at 90% 5 year treasuries, so the only way they would get to 0% would be if treasuries trade that low (which they shouldn't even if the Fed rate is 0%). They can't go negative.
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