Business and Finance

Archive for the ‘Corporate Bonds’ Category

As a budding investor there are two questions that always come up: 1. Where to invest money?, 2. Where to invest money? Let me elaborate. There are many different types of institutions to do your investing business with. There are also different types of investment vehicles that you can use to invest your money. Thus the two questions…Here are my thoughts on answering both.

You cannot answer the 2nd question without answering the first. We must find a business to invest our money with. Here, we go to the internet. There are a lot of reputable stock trading firms that have been in business a long time that you can do business with. Scottrade, TDAmeritrade, Fidelity, Charles Schwab, are a few that come to my mind right away. There are also other companies that are on the internet that you can visit. Companies like, Sogotrade, Etrade, Trademonster, and Firstrade.

They may be newer to the stock trading scene but reputable, nonetheless. There are also online banks that you can open savings accounts with like: ING, HSBC, and Emigrant Direct. How to pick them? Here are some criteria that you should consider: reputation, cost per trade, resources, customer support, user friendly. To do this, you must educate yourself on all the options available before jumping into one that has the coolest TV commercial. Research first, figure out what company to invest your money with, then you can answer the 2nd “Where to invest money?” question.

After answering the 1st “Where to invest money?” question, you now know that you can use the internet to do all your investment education, financing, banking, etc. What kind of investments are there? Well, there are savings accounts, money market accounts, Certificates of Deposits (CDs), corporate bonds, municipal bonds, exchange traded funds (ETFs), stocks, mutual funds (load and no load), Real Estate Investment Trusts (REITs), Government securities, and precious metals.

There are more but you get the idea, there are a lot of vehicles to place your money. The right questions to ask yourself are: How much do I have to invest?, How long do I want to invest it for?, How much return do I want?, and What is my risk tolerance?. Once you answer those questions, you will be able to narrow down your choices. Bottom line is do research and educate yourself before jumping in.

In the investment world, there are two words we hear more than any others–stocks and bonds. While each can offer their own advantages and disadvantages, both should be included in your portfolio. As a general rule, stocks have outperformed bonds since 1926; returning 10.4 percent against government bonds’ 5.4 percent showing.

However, when stocks go bad–and they will–bonds will always be there for you. Over short periods of time (like the bear market of 2000 to 2002) bonds easily outpaced the growth of stocks. However the world of bonds can be a confusing one, so let’s learn a little more about them.

Why to get fond of bonds

The first word in smart investing is “diversification”. That means you own a good mix of volatile stocks and steady bonds in your portfolio. When one takes a hit, the other will usually hold steady.

Whereas stocks will only give you liquid results when you sell, bonds pay interest regularly, making them an attractive investment choice for retirees looking for regular income.

Bonds are also some of the some of the safest investment choices you can make, second only to cash. U.S. Treasuries offer a risk-free vehicle of stashing funds for a limited amount of time, and you’ll usually see modest gains while you’re at it.

Also, many bonds provide income that’s tax-free. That’s a good thing, even though most of these pay a lower yield than what you might get from taxable bonds.

Bonds at work

When you purchase a bond, you’re basically lending money to a corporation or the government so they can go about their everyday business or complete certain projects. In return, they pay you interest annually and then give back what you’ve invested once the bond “matures”, meaning its term ends.

Now for a little lingo. A bond’s “par value” is the price paid for it when it was new. A “coupon”, is what the bond pays annually in interest. For example, a $10,000 bond paying 8 percent a year would have a coupon of $800. If you don’t buy a bond new, you’ll be purchasing from another person in the “secondary” market, and you’ll pay the current market price on the bond (which fluctuates daily) though still receiving the same coupon. A bond’s “total return” is all the money you will earn off of the bond. That includes the annual interest along with its loss or gain in the market.

Bountiful Bonds

There are a ton of bonds to choose from, but the safest choice is a U.S. Treasury. Interest and payments on these are guaranteed by the “full faith and credit” of the United States Government.

Within Treasuries, there are several bonds to choose from, all requiring different investment commitments, terms, and interest rates.

You can also choose from mortgage-backed bonds, which can yield around 1 percent more than Treasury bonds with a typical $25,000 investment. Then there are corporate bonds. Most of these are issued in $1,000 denominations and have terms ranging form one to 20 years, or even a few weeks to 100 years. The values of corporate bonds depend on the credit of the company you’re bonding. Like everything else, it’s a risk-reward proposition when selecting a corporate bond.

Finally, you can also purchase municipal bonds in state and local governments and agencies. These are usually available in denominations starting at $5,000, with terms of 30 to 40 years. The great thing about municipal bonds is that your interest returns are typically exempt from most federal, state, and local taxes.

Risk-Reward

Though bonds are typically less volatile than stocks, there are still risks. Interest payments can be worn by inflation. If interest rates rise, bond prices will fall. Also, some bond issuers reserve the right to “call” back bonds before term. If this happens, you’ll only get “par value” on the buy back, though “callable” bonds offer higher interest returns than noncallable bonds. Also, if a corporation you have bonded goes belly-up, say goodbye to your money. Finally, bonds, as with most investments, are at the mercy of the ups and downs of the everyday market. Just remember, the longer before your bond matures, the more unpredictable it becomes.

In a life filled with risk, it pays to play it safe sometimes as the smart ones have learned with corporate bonds. What are corporate bonds? They are the money raised by corporations over and above the sales, services, loans from banks and stocks. Unfortunately, not too many investors have taken the time and the effort to understand this instrument.

A bond is a loan to a company and like loans, there is a date when the loan has to be paid back and a rate of interest that has to be paid on that loan in the meantime. Bonds are usually with companies for 10 years after which they reach their maturity date.

While they are relatively safe, bonds too have certain risk factors which we are going to look at. These can be classified under the terms Credit Risk, Interest Risk and Maturity Risk.

There are defaulters where bonds are concerned too and even after not paying their debts, companies just can go on, carrying on with their business. So you have to make up your mind whether you want to sue or to settle. There are, happily, credit rating agencies which rate the credit risk of a company. Poor’s and Moody’s and Standard are two such agencies.

There is a coupon rate or an interest rate attached to each bond – however, these may change depending on market factors. Interest rates can change as well and you might get lucky and find that the interest on your bond has gone up. When you want to sell a bond, you will find that it fetches a better price on maturity than before maturity or if it has just been bought.

There are some bonds that are allowed redemption before they mature. These are called being ‘callable’. So they can pay for the bond you hold with cash or issue new bonds against it or maybe even a bank loan. This means that if you have been used to getting a high rate of interest, this might suddenly stop if the company tends to call up the bond.

Let’s now look at the advantages. If you are cautious and invest in high yield bonds that are healthy and not junk bonds, you can stand to gain a lot. You also have convertible bonds where you can buy bonds that convert into stock directly from the company rather than from the market. This means you can take advantage of the company’s price appreciation while enjoying the safety factor of a bond. The price of the bond usually does not fall below a decent price return.

Like any other financial investment, you need to make informed choices and for this, you need to be well up on what is happening in the market. The great thing about bonds is that the benefits as well as the risks are transparent and easily gauged.

What do you do if you need investment income?

Equity returns are negative or very volatile Property funds are lowering dividends Savings and fixed deposits returns are declining and are negative after inflation and taxes

Are corporate bonds the answer?

In Germany, Italy, Australia and New Zealand big new corporate bond issues are being snapped up by private investors. In Japan where equities, property and deposits have been unattractive for years – retail investors bought just over a quarter of investment-grade bonds issued in the first quarter this year.

On the face of it corporate bonds or bond funds are attractive, for example the Markit iBoxx euro-denominated corporate bond index, filled with well known companies and with a coupon of 5.2 per cent, is currently yielding 7.2 per cent.

In the UK, corporate bond funds accounted for three-quarters of net retail investor sales in February, according to the Investment Management Association.

But you should be careful.

Any new investor in corporate bond funds hoping for quick return may be disappointed. Credit markets are in a severe slump and as a result is largely immune to the increases in other assets. Additionally with bonds the potential upside is limited while the downside caused by deteriorating credit worthiness and interest rate movements can be substantial.

Furthermore investors should bear in mind that there are good reasons why bond markets have historically been dominated by professionals. An investor buying a share in a company has one thing to monitor. With bonds, there may be dozens of alternatives from the same issuer, each with its own interest rate curve and maturity.

Also prices are driven by credit worthiness, expressed by credit agency ratings. In the first quarter 2009 the rating agencies have reported the largest number of companies with rating deterioration since the depression in the 1930′s.

Also trading volumes are low. For example no Vodafone bond has anything like the liquidity of the stock. Private investors should also be weary of markets where professionals are staying away. Investors with long term inflation expectation will also do well avoiding long term fixed rate bonds as they would most likely be the worst performing asset class.

The question remains…

What do I do with my cash at the moment?

I am currently more than happy to keep my cash in call and term deposits with a stable bank that had adequate deposit insurance. Should your cash holdings exceed the deposit insurance limit I suggest you spread the cash around to ensure you have adequate cover. Now is not the time to run after long term investments with high yields in an asset class you have little knowledge of.

If you want to make good money with banks, or any institution, Government and agency bonds are where it is at. Simply because all Government bonds and agencies are AAA rated, and banks can buy millions of dollars of any bond without incurring any credit risk.

All banks own bonds of some sort, and they are buying them from brokers. Our primary bonds are:

U.S. Treasury obligations (T-bills, T-notes, T-bonds) Government Agency Debt (GNMA) Private Agency Debt (FNMA, FHLMC, FHLB and others) Mortgage Backed Securities (Pass throughs , CMO’s, ARM’s) Municipal Bonds Investment Grade Corporate Bonds
The institutions that have strict policy guidelines on the bonds that they can buy are Banks, Credit Unions and Municipalities.

The spreads on Treasuries make them difficult to sell or “mark up” more than a few “ticks” to most sophisticated banks and institutions. A tick is 1 point in price. Government bonds are quoted in 32nds.

An example of a treasury bond would be: Bid 101-16 Ask: 101-24. If your client wanted to buy $10,000 of this treasury bond, you would see the price to you at 101-24 (24/32). 24/32 = .75. So the price is really 101.75 or $10,175. Each point represents $10 for every $1000 par bond. For $10,000, each point is worth $100. All bonds trade at a minimum of 1000. Institutions normally buy $250,000 up to tens of millions per trade. So, our example of a $10,000 trade really isn’t realistic and would not be worth your time. A “tick” by the way, is if the price went up to 101-25.

Trading for a few “ticks” on $100,000 would make you very little. If you factor in ticket charges, you might make $100 on the trade. You only present treasuries if it’s non competitive, or if the client is investing at least $1,000,000, otherwise it won’t make you much. If your client deals with 3 other brokers on treasuries, you will all be fighting for very little money. It’s very easy to get a quick quote on treasuries. Every major dealer owns them, and they can be purchased quickly. You or your trader will contact a major brokerage firm (Merrill Lynch, UBS etc.) and buy them. Not much money yes, still, it is assets you are controlling, and it could be used as available money to swap out of into a better investment for the client.

Treasuries are very safe of course, that’s why they are bought. Only buying treasuries will diminish the rate of return of the entire portfolio, if that is their only or main investment vehicle. Treasuries offer flexibility though. The market values on them will normally hold up well over time. They are very liquid and can be traded instantly. You should sell them only as “time bucket” or maturity gap placing.

If you see the bank has nothing maturing in the first half of a year for instance, you can recommend treasuries there too. Remember, institutions are looking for best price, but also good advice. The medium sized banks ($50 million – $500 million assets) will value good planning and thoughtful recommendations over dealing with 10 brokers all day. The larger institutions are more complicated, and require more price awareness. They think they have the ideas covered and you may have to just be an order taker with them.

How To Sell Mortgage Backed Securities or CMO’s

Mortgage backed securities offer the best alternative to decreased loan demand. Pass throughs, CMO’s and adjustable rate MBS’s are paid to the bank just like a loan that the banks has made for a mortgage. If a person takes out a $250,000 mortgage, the customer is paying back the bank monthly with principle and interest. As you know, if you own a home, your initial payments are mostly INTEREST in the early years. A mortgage backed security, if it is a new issue will operate the same way.

Length of the outstanding mortgages, or current face of the mortgages are a factor. “Seasoned pools”, as they are called, are mortgage pools that have had several years of payment on them. They have more predictable payments and duration. They will normally pay better because of that. Seasoned pools are usually what banks are looking for. They are generally interested in better cash flow and predictable cash flow.

The compensation or mark up potential is good in mortgage backed bonds. They are priced above treasuries because, although they are AAA rated, they are not absolute in their pay off and the payments fluctuate. Since they are usually 15-30 years in duration, they allow for price mark up. Where treasuries and straight agency debt allow for a few ticks to a .25, MBS’s can create spreads between buying and selling them up to a

Many people think of any type of dollar denominated bonds, whether they are U.S. corporate bonds or U.S. Treasury bonds as a safe place to park your money for reliable sources of income stream. In fact, the U.S. Treasury Department on their own website, even tout U.S. Treasury Securities as a “great way to invest and save for the future.”

Many people believe this nonsense because they are advised of this by a horde of financial consultants that have zero understanding of how the political-corporate-banking triumvirate operates, and how this financial triumvirate has produced a most unattractive likely scenario for dollar-denominated bonds going forward from 2007. Many people think of U.S. Treasury bonds as safe because of the “federal guarantee”. The ten reasons below render that federal guarantee irrelevant.

And don’t think this doesn’t affect you just because you aren’t American. Non-Americans aggregately hold a lot more U.S. dollars in this world than Americans do. If you are one of those misled people, American or non-American, reading the below ten reasons can save you a lot of grief in the future.

(1) The often repeated financial consultant statement that bonds are a “safe place” to park your money, especially if you are older, is a myth. Who cares if you earn a 5% revenue stream from bonds if the currency they are denominated in loses 15% in value over that same time span?

(2) Many of those in the retirement phase of their lives are convinced to invest in longer maturity bonds because of poorer yields of short-term bonds. As the Euro gradually replaces the U.S. dollar as the international currency of choice, the longer maturity necessary to ensure a return of face value on bonds presents a significantly greater risk.

(3) As interest rates go up, the face value of bonds go down. Although Wall Street strongly expects the U.S. Federal Reserve to cut interest rates soon to stimulate a faltering U.S. economy, this is how I see it. At some point and time, the U.S. Federal Reserve will try to block global flight from the U.S. dollar by propping up interest rates, not cutting them.

(4) As the dollar loses value over time, banks and other financial institutions will increase interest rates on loans and other financial instruments to compensate for the heavy losses they are incurring on a weakening dollar. As your costs of doing business and living rise, yields from bonds won’t cut it anymore.

(5) As the massive yen carry trade continues to unwind, and the Bank of Japan takes increasing measures to strengthen the Yen as the Japanese economy continues emerging from its recession, the strengthening of the Japanese Yen in addition to the Pound Sterling and Euro will threaten dollar supremacy.

(6) While most people think that there has been no further attack on the U.S. by terrorists since 9/11, there has been a far more devastating ongoing attack – an ongoing economic war. Though this fact is not discussed at all in the mainstream media, Osama bin Laden’s has repeatedly stated that his number one goal to topple the U.S. as an economic power.

(7) In response to (6), the U.S. Federal Reserve has expanded the dollar money supply to provide funding for the war. With no end in sight to this war, we can expect the dollar money supply to continue to expand, therefore placing more downward pressure on the dollar.

(8) The U.S. has no powerful allies to keep the dollar strong. With protectionism sentiment growing stronger among the newly elected Democratic U.S. Congress, the U.S. certainly has no friends in China, the largest holder of dollar denominated debt at over $1 trillion.

(9) The largest holders of Petrodollar reserves include Russia, Venezuela, Iran and other Middle Eastern countries. Read that list again. There is not a single nation strongly friendly to the U.S. on that list.

(10) When people finally realize that (1) through (9) are true, there may be a flight from the bond market, causing bond prices to tumble.

When you realize the shakiness of your situation as a dollar-denominated bond holder, think about this. Don’t you think foreign governments and wealthy private institutions and individuals, holders of dollar-denominated assets in massively greater quantities, realize the same? When they realize the facts that I’ve laid out above and take actions, their aggregate actions will reflect poorly upon dollar denominated bonds as well.