Corporate Bonds - Very Basic Questions

Discussion in 'Stock Market Education' started by crimsonghost747, Dec 2, 2014.

  1. crimsonghost747

    crimsonghost747 Senior Investor

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    Ok, so I've been investing for a few years now and I just realized that I don't know anything about bonds.

    So after a bit of reading, let's see if I figured them out correctly.
    Let's take this Starbucks bond as an example:
    http://finra-markets.morningstar.com/BondCenter/BondDetail.jsp?ticker=C598631&symbol=SBUX4047665

    So. Phew. Where do I start.
    Current price is $107 (I rounded off the cents to make it a better example)
    Call price is $100.
    Call date is 07/01/2023.
    Coupon rate is 3.85%
    Payment Frequency is Semi-Annual

    So assuming that today I will buy 100 of these, I will pay $10700. (plus commission to my broker)

    From here on, all the way to 07/01/2023, I will get $385 per year as interest. [$100 (call price) x 3.85% (coupon rate) = $3.85 per bond. x 100 because I bought 100 bonds) This interest will be paid twice a year so that means $192.5 per payment. Where can I get these payment dates?

    On 07/01/2023, when the bond expires, I will receive $10000. [$100 (call price) x 100 (amount owned)

    So I pay $10700 now, get $385 for 8 years (roughly 8 years left before maturity) and I get $10000 back in the end.
    So $10000 + (8x $385) - $10700 = $2380 of profit before tax and commission.

    This income is certain, unless Starbucks goes belly-up or chooses to recall the bonds. (as this bond is callable) If they choose to recall the bonds, I get $100 per bond (call price) and obviously the interest for the time between tomorrow and their recall date.



    So, are all (or at least most? :D) of my assumptions correct?
    Provided that I do not wish to sell these bonds before the call date, is there anything else that I need to worry about?
    Anything important that I missed?
     
  2. JR Ewing

    JR Ewing Super Moderator Staff Member

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    You should be able to get the payment dates of the bonds from the prospectus issued by the company who issues the bonds themselves. The prospectus should be available through your broker, as should the payment dates themselves. I'd call your broker or discount broker's customer service dept to get that info if it's not showing up electronically.

    Other than the risk of default (no matter how small), one other thing to keep in mind is that the day to day trading price of the bonds will fluctuate in both directions. It's possible that a bond now trading at $107 may be trading below $100 at some point in the future between now and the call or maturity date. This is even more likely when we're in this current "zero-interest rate environment" where rates will eventually inevitably rise.

    Of course it's less likely that the bonds will be called anytime soon, since they will probably have to pay more interest if they issue new debt in the near to midterm when rates are likely higher than they've been in recent years.
     
  3. crimsonghost747

    crimsonghost747 Senior Investor

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    Thanks for the reply JR. I was actually hoping for you to drop by and offer your thoughts.

    Yes the fluctuation in price is always there but if someone is planning to keep the bonds until maturity then this fluctuation has no effect, right?

    Basically what I'm looking at is throwing a part (around 20%) of my savings account money into corporate bonds. Maybe 5 different bonds, with different maturity dates. Originally this savings account was started to save up for a house/apartment but in my current situation it looks like I won't be buying one in the next few years so I'm looking for a way to get a little higher interest rate with significantly less risk than with stocks. (which is where most of my current investments are) The amount I will have left in the savings account will be enough for the down payment of the house/apartment, so I don't have to worry about getting rid of the bonds before maturity. And with different maturity dates on the bonds, when ever one of them reaches the call date I can either reinvest it into another bond or, if I did end up buying that house, just use it to pay off part of the mortgage.

    That is the current plan anyway. I just started working on this yesterday, so I'm still not very heavy on the details. :D
     
  4. crimsonghost747

    crimsonghost747 Senior Investor

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    Started looking for the prospectus, which by the way was the exact thing I needed to find all the details I need. Found the payment dates, minimum investment and much more useful stuff. :)

    I'll throw the process up here in case people want to take a look. I find this to be an easy way to find them.
    All the US corporate bonds are listed in EDGAR.
    http://www.sec.gov/edgar/searchedgar/companysearch.html
    Just insert the name of the company, then click on the appropriate CIK.
    And filter with "filing type: 424"
    Then find the proper one based on the dates.

    And voila, prospectus for the same Starbucks bond.
    http://www.sec.gov/Archives/edgar/data/829224/000119312513356975/d591149d424b5.htm
     
  5. JR Ewing

    JR Ewing Super Moderator Staff Member

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    Yeah, the typcial fluctuations are not an issue if you're thinking past today and the end of the month. Some people freak out if they buy a bond at $1000 and if it's current market value ever dips below that on monthly statements inevitably at some point in the future - even if it was clearly explained to them before they bought it. Those people either need to come to terms with reality or else stick to checking and savings accounts and traditional CDs that usually pay less than inflation.

    The "laddering" of bonds by buying several different bonds with different maturities is a good idea. That's a good way to help avoid liquidity crunches and also reduce future interest rate risk.
     
  6. crimsonghost747

    crimsonghost747 Senior Investor

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    Ok one more, very basic, question. Let's use the same starbucks bond above as an example.

    The prices are always quoted as something close to $100. Now it seems to be at $107.35.
    However looking at the prospectus, it says "The notes will be issued only in minimum denominations of $2,000 and integral multiples of $1,000 thereof."

    So... how does this work? Do I have to buy a minimum of 20 to get above that $2000? Or are the amounts on the prospectus only valid for the initial offering, and now on the secondary market I can buy as little as I want?
     
  7. Peakwealth

    Peakwealth Guest

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    Fyi your initial calculation is off. If you bought 100 bonds, you'd be paying $107,000. The par price of a bond is usually $1000, so a bond trading at 107 would cost $1,070. Your calculations are based on 10 bonds. Other than that the #s look accurate. I didn't dig into the prospectus, but make sure you're clear on call provisions. A call is when the issuer redeems the bonds before the maturity date (2023). With there is a call provision, the danger for you in buying a bond at a premium (above par) is you don't get enough interest payments to make up for the money you're losing ($700) due to the early redemption. As JR mentioned, if you're holding these to maturity then the fluctuation in pricing shouldn't be a factor for you, but do know that a bond maturing in 2023 will fall in value as interest rates rise, which obviously is something we're expecting over the next 8 years. Also, that $2000 minimum is only for the initial offering. If they're trading on the secondary market, you can buy as many or as little as you want.

    Something to think about as well - you say you're going to be setting up a bond ladder with the remainder of your savings after putting a down payment on a house and paying down the principal as the bonds mature. That's logical - but you should crunch the #s to ensure it works in your favor. With taxable corporate bonds yielding 2.8%, your after tax return is around 2% if you're in the 28% tax bracket. If you're buying a house with a 4% mortgage, your net interest after tax deductions might be 3%. In this case, you're better off paying down the mortgage instead of investing in the bonds since saving 3% in net interest is better than achieving a net 2% return on your investment. If you can make better than 3% on your investments, then keep those funds invested. I don't know your overall situation, so best to speak to a financial advisor who can help you develop a plan considering all of your goals and needs.
     
  8. JR Ewing

    JR Ewing Super Moderator Staff Member

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    Some bonds are in fact $100.

    One thing I will say regardless is that you're better off buying bonds at or below par value if possible. It can be difficult in this interest rate environment, but I recently grabbed some oil & gas at pretty good interest rates trading at fractions of par value. Of course you need to do your homework when buying any individual bonds, and buy enough from enough different companies so that default risk is minimized when buying riskier debt.

    Perhaps the best bond hustler in the world IMO: http://quotes.morningstar.com/fund/tgbax/f?t=tgbax
     
  9. JR Ewing

    JR Ewing Super Moderator Staff Member

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    Some bonds are in fact $100.

    http://www.investopedia.com/terms/p/parvalue.asp


    One thing I will say regardless is that you're better off buying bonds at or below par value if possible. It can be difficult in this interest rate environment, but I recently grabbed some oil & gas at pretty good interest rates trading at fractions of par value. Of course you need to do your homework when buying any individual bonds, and buy enough from enough different companies so that default risk is minimized when buying riskier debt.

    Buy fewer and shorter term bonds when rates are low, more and longer term when rates are high if possible. Of course people who are retired and just using bonds for income who may not care about short term value fluctuations are primarily looking for a certain amount of interest and usually a highly likely or at least reasonably likely expectation of return on principal at maturity.

    Perhaps the best bond hustler in the world IMO: http://quotes.morningstar.com/fund/tgbax/f?t=tgbax
     
  10. crimsonghost747

    crimsonghost747 Senior Investor

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    Yes I'm aware of the calculations between the yield on investments and interest paid on mortgages. The main thing is that I don't know when I will be buying my house... so I really need to get this money off from the super low yielding savings account. Maybe I will buy the house in 2016... maybe in 2026. I simply don't know. In any case, right now the savings are just going down due to inflation so I need to get some of that money working for me.

    Ok now so I'm still confused about this par value. I know what it means etc... but where do I find it? Take the starbucks bond for example: I searched through the prospectus with "face value" "par value" "par" etc... and couldn't find it anywhere. Now I understand that the large majority of corporate bonds are at $1000 but logic states that I should be able to verify this before I buy $100k worth instead of $10k. :D

    And yes JR, my investment strategy is pretty much based on the whole predictable income from dividends/interest. I'm young but I invest a lot like someone closing in on retirement. :D So that will be the main idea of these bond investments, bringing in a bit more income while keeping the principal as safe as possible.
     

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