Exploring Bonds

I want to buy some corporate bonds. Verizon recently issued a record amount and I’m thinking about getting in on the 10 year 5.15% tranche before they become too popular 😕 Making over 5% return a year doesn’t sound too bad 🙂 On a risk adjusted bases this BBB+ bond offering is probably one of the best investment opportunities out there today \(^_^)/

What Is A Bond?

(Besides a spy who drinks martinis and works for the British Secret Services)

A bond is a loan between a lender and a borrower. It’s basically an I.O.U. contract 🙂 Normally consumers borrow from banks. For example someone gets a $10,000 loan from BMO so they can buy a car. A bond is similar, but the other way around 😎 which means the bank borrows money from the consumer and of course pays interest to the consumer. Sounds like a sweet deal doesn’t it? 😀 Anyone else interested to buy some bonds with me? I’ve only bought bond funds in the past, but never individual names before. But hey, we learn by doing 🙂 and sometimes that means stepping outside of our comfort zone. quote-alone-neverbeen-follows-crowd

How A Bond Works

Let’s say BMO bank wants to borrow $10,000 to buy a company car. It wants to give itself 10 years to pay off the loan and offers a 5% interest rate to whoever lends it the money. First BMO issues a bond with those details and the bond is put up for sale. Now let’s say you decide to buy this bond. You would lend BMO $10,000 of your own money in exchange for this bond. Every year BMO pays you $500 in interest. When the bond matures at the end of the 10 year period, the bank would return your original $10,000 principle and the bond contract ends. Congrats. You turned your $10,000 investment into $15,000 over 10 years. Much better performance than storing that money in a savings account or GIC eh? 🙂 Bonds are usually safer than stocks because creditors are senior to shareholders. In other words, if BMO somehow goes bankrupt they have to liquidate and try to pay back your $10,000 principle in full before the stock holders get any money. 😀

Every bond issued will have 3 important numbers that investors should be aware of. The Face Value, the Coupon (interest rate,) and the Maturity date. In our example, these numbers are $10,000, 5%, and some time in 2023 respectively.

Why Don’t Bloggers Talk About Bonds More Often?

The bond market is actually larger than the stock market. More bonds are traded everyday than stocks. And bonds influence our economy, mortgage rates, and everyday lives in general way more than stocks do. So bonds are popular, at least among investors. But bonds can become complicated by interest rates, credit ratings, timing restrictions, and other factors which make them difficult for the mainstream consumer to understand. Investopedia has more info about this asset class if you’re interested in exploring bonds further.

Random Useless Fact: All species of mammals have about the same number of heartbeats in their lifetimes.

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09/25/2013 3:06 am

Bonds aren’t as popular as stock because they aren’t “sexy”. They don’t move fast. They are predictable in your return if you hold to maturity. Not much to talk about them as far as bloggers go.
But I do think they have a place with investors. At least my own portfolio.

09/27/2013 3:32 am

Well its a down a dirty quick stat mostly for people who do not want to put a lot of time and effort into something as unimportant as their financial well being for the rest of their lives.

On a serous note though… I would only consider a defined pension plan and bonds to be similar if they came from the U.S. government. I do consider Social security as similar to U.S. Treasury position as they are backed by the same entity and theoretically would default at the same time.

09/25/2013 4:03 am

We hold no bonds. We consider our owned, properties to be bond like investments. They are slow grow, and hold their value with basic up keep. They account for close to our age as a percentage of our net worth. I would much rather have the protection of inflation adjusted stocks to rely on to grow my money. I realize bonds work for others, but I’m not one of them. Even later in life with proper planning, stocks can provide a relatively stable supply of income flow. For us stocks provide more potential opportunities to grow our money… Again, long term planning is the key, which unfortunately many neglect to realize early enough – Cheers.

09/25/2013 5:21 am

For many average investors, bonds are tricky for the reasons you point out. Knowing how interest rates effect bonds, maturity, etc. all play a role. This is why bond mutual funds are more common for the average investor. There is a lot less work to be done while still getting the benefit of investing in fixed income securities.

09/26/2013 10:22 am

Interesting. Thanks for explaining bonds in such an easy way I can understand them! 🙂

09/29/2013 3:38 am

I would be careful about getting into bonds right now. Verizon is an Investment Grade name (AAA-BBB-) so is priced as a spread off of a treasury. While the spread and consequently total yield look very attractive given where other bonds trade, know that there are two reasons why this bond could get even cheaper. 1) Interest rates rise 2) supply/demand technical. On number one, when the Fed decided to hold off the taper the 10yr treasury tightened in 30bps to mid 260s. I think the medium term area for where the 10yr should trade given a growing economy and stricter monetary policy is 3.5-4% which is a loss of 100bps at the minimum on the verizon bond. Now when this happens you are talking about a 15bn tranche so when bondholders and companies trim their bond portfolio which bonds do you think they will sell? Probably the ones they have the biggest holdings in which will create a scenario where there are more sellers than buyers which will cause the bonds to be cheaper. If you want to hold until maturity it’s a fine bond to get into (ie safe and cheap) but I think a more attractive asset… Read more »

09/29/2013 3:57 am
Reply to  Chuck

Also I just checked and they are trading at ~4% yield and that’s for institutional accounts. I’m sure for retail they would jack the price on you.

09/30/2013 3:59 pm

As it happens, I am a professional bond trader. Investing in individual bonds is difficult for most retail investors given the different issues and the demand/supply challenges that change all day every day. As we make markets in bonds the prices change on a minutely basis given what’s happening in rates, supply, and direction of flow. Unless you in immersed in the trading I don’t think you can accurately make educated risk decisions on single issues though there will always be supply with that Verizon 10yr bond haha. I would recommend to all retail investors that you invest in bond funds with companies who have low fees as they have economies of scale and information necessary to make prudent risk decisions at efficient prices. But those are just my two cents on the matter.

09/29/2013 1:01 pm

I’ve been studying more about stocks and bonds lately. This article is really helpful. Thanks for sharing.


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