Bonds and their unique characteristics
The Moneywise Pretend Portfolio yearlong series has been updated to reflect stock and bond prices at original issue and as at end of January.
The portfolio is not yet complete as each month in the year-long programme,
but please take the time to see what Moneywise has laid out for your perusal and contemplation, this week.
Investing is long-end game.
The stock portfolio section aptly demonstrates that from the original IPO (initial public offering) of most of these companies' stock to the present — the value has appreciated substantially over time, some gainers appreciating exponentially.
For example: Amazon, Chubb, Mastercard, Cigna, JP Morgan Chase. For as many gainers, there are company stocks that have not done as well. Buy and hold demands confidence in the company value, performance, and patience in the outcome.
Sometimes, it is better to expunge a loss, but that is a detailed discussion for further months in this series.
This week, Moneywise is focused on four individual bonds selected for the portfolio: what they are and are not; how they work; what causes the values to change.
• A Bermuda government bond
• A United States Treasury bond
• An Argentinian government bond
• A multinational AT&T Inc corporate bond
There are stark differences between them.
The important facts in a perfect bond world, note I emphasise perfect!
1. No matter what price a bond is bought, high or lower than par ($1,000 or 100 per cent), at maturity only 100 per cent will be returned to the bondholder.
2. The coupon interest rate payment does not change for the life of the bond, except if the bond issuer defaults.
3. Bond prices after launch will generally fluctuate somewhat (or a lot) reflecting various current market conditions.
4. Bond yields, which are not the same as the coupon rate, will respond inversely.
• When bond prices are above par — see the US treasury priced at $1,426.80, the yield is below the coupon rate of 6.25 per cent. Why — because at maturity only $1,000 is paid.
• When bond prices are below par — see the Argentinian bond price of $422.50, the yield is way above the coupon rate. Why? because under ordinary circumstances, the $1,000 would be paid at maturity. However, the credit rating is poor — so it is highly unlikely bondholders will receive all their principal back. The high yield is meaningless.
The most common market signal situations are:
• Changes in market interest rates
• Economic uncertainty
• Market volatility
• Credit ratings - from high grade - to high yield
• Safety concerns
We can see this bond market price fluctuation in our Bermuda government bond February chart feature, slightly above and below par of 100 over the almost six-year period.
This Bermuda government 12/23 bond was issued on July 3, 2012 in US$1,000 increments (estimated 200 million plus) around a 100 per cent price value, paying 4.138 per cent, annually with a maturity date of 2023.
Unfortunately, ordinary Bermuda islanders were not offered the opportunity to purchase these bonds. Bermuda islanders through their taxes have to pay these debts back; surely, it would feel better financially and psychologically, to own some of our own debt, earn the interest as well.
There is nothing like managing one's finances very carefully when one is responsible to pay debt back.
This Bermuda bond (like most bonds) possesses various attributes, see a more complete description in the downloadable portfolio February 2020:
• Principal face value, $1,000 each
• Coupon interest rate, 4.138 per cent, annually, paid in two six-month increments. This rate is paid, no matter what the yield on the bond is at any given moment
• Maturity date, 2023, where the entire principal is returned to all bondholders (or sooner)
• A prospectus that describes in great detail the Bermuda government finances, some 92 pages: history, geography and population constitution, government and legal system and international co-operation, military, independence, infrastructure, employment, education, social welfare, economy, balance of payments and foreign trade, money supply and foreign currency reserves, tax policy, public finance, public debt, Litigation, political economy, and much more
• Listed on the Luxembourg and Bermuda Stock Exchange (the prospectus available for download)
• Credit rating, S&P rated A+
Safety and security
The safety factor and high credit rating, for example, means that if you purchase a US Treasury of some interest rate and maturity line, you are almost assured you will receive all of your principal back. The most dominant global country offers safety and quality at a price — low coupon interest rate.
The Argentinian bond seems a better buy at 7.625 per cent coupon interest rate with its yield a whopping 21.80 per cent as at January 27, 2020. But, the price is only 422.50 pesos. The credit rating is low.
Do you think bondholders will get 100 per cent principal back?
Issued at 100, now at 42.25, I think you know where this 872 million bond issue is heading. Default or renegotiation of principal return — downward. A very large loss. That high interest doesn't seem so great now, does it.
What a difference!
Bonds: high grade = low risk, low returns, contrast with high yield = high risk, high returns, but?
High-grade bonds are considered the best in the safe haven category — remember credit ratings in triple/double A category. The highest credit quality bonds provide security of assurances in getting your original principal investment back at maturity, diversification, a hard currency, liquidity if you must sell in emergency, some capital appreciation when markets are shaky and bond prices are demand-driven higher.
Stay tuned for next month.
Business Insider subgroup MarketInsider: https://markets.businessinsider.com/bonds, wonderful, very comprehensive bond tracking research website.
Seeking Alpha: https://seekingalpha.com/. Join for free, now with more than eight million subscribers. Read commentary by numerous analysts, independent investors and the like, set up your own portfolio tracking system.
Investopedia: probably the best for detailed articles on just about every investment topic out there. Provides numerous classes in various topics for generally, reasonable fees. https://www.investopedia.com/. Sign up for free for the Investopedia Daily newsletter. Chock full of articles!
• Martha Harris Myron CPA CFP JSM: Masters of Law — international tax and financial services. Dual citizen: Bermudian/US. Pondstraddler Life, financial perspectives for Bermuda islanders and their globally mobile connections on the Great Atlantic Pond. Contact: email@example.com