Douglas Goldstein: Hi, I’m Doug Goldstein with the Profile Financial Academy.
You know sometimes your advisor or your broker sends you a bond ladder and you have to look
at it and you’re not exactly sure what’s going on there.
So I put together a couple of videos to help explain how you read a bond ladder proposal.
This is going to be in several parts.
I hope it’s helpful.
If it is or you could use a little more information, you can go to our website, www.profilefinancialacademy.com.
We have even more in depth courses there about not only bonds but stocks as well as mutual
funds and of course if you have any questions, send me an email to doug@profile-financial.com.
Okay, so let’s jump right in.
If you have gotten a proposal from your advisor, it probably looks something like this, it’s
called a fixed income bond ladder.
Even if you’re not a client of a broker who is using net exchange like the example
that I’m showing you here, most likely the bond ladders that you’re getting all look
pretty similar.
This is specifically designed for people whose advisors are using Pershing which is a division
of Bank of New York but again any advisor that’s showing you a bond ladder will have
all of this information on the proposal.
What I’d like to do is I want to cut ahead to the end of the proposal.
So we’re going to pass the cover page here and we’re going to pass the summary page
and we’re going to pass the credit quality and the different types of debt that you have.
We’re even going to pass over the estimated cash flow.
We will cover this in a later course but let’s get right to the details which is what are
the specific bonds that you’re looking to buy?
So here we are, we’re zooming in to look at what each of the different columns mean
on this portfolio.
So the first column is quantity.
It says in this case that there are 25 bonds.
Now bonds are issued in thousand dollar units.
So when you say that it says 25 bonds, you know that you’re talking about a portfolio
of $25,000.
Now the $25,000 is the amount of money that the bond issuer owes you when the bond matures.
The next column is called the CUSIP number.
The CUSIP number is simply a number which is what securities, traders and brokers and
brokerage firms use to identify different securities.
It’s kind of like the social security number for a specific bond.
Now we’ve got a description of the bond.
The first one in our list is International Lease Finance.
It’s a company that buys airplanes and leases them back to the airlines.
It tells you the name, it gives you the coupon rate and then we can scroll to the right a
little bit more and see what the rating is of this bond.
In this case, it’s got a B1 rating from a company called Moody’s and a triple B
minus from a company called Standard & Poors.
Let’s talk about the Standard & Poors for a minute.
Bonds that are considered investment grade which is the higher quality bonds are usually
triple B minus or better.
The list starts at triple A, double AA, triple B, double B and all the way down.
Triple B minus or better would be considered investment grade and below that would be called
high yield bonds or often sometimes simply referred to us junk bonds.
Now this specific bond has a coupon of 5.78%.
That means that for every thousand dollar bond, they will pay you $58.75 per year.
Okay, you can check out the math on that yourself.
You can put in a thousand dollars for each bond, you multiply that times 5.875% and then
you’ll see that you get $58.75 per year.
The fact is most bonds pay the interest in every six months so you would take your $58.75
divided by 2 and for every bond you would get $29.38 cents every six months.
Okay, let’s move the calculator to the side for a minute and keep going on the chart.
Next let’s see what the maturity date is.
In this case, the bond matures on May 1st, 2013.
That means that on that date, the company International Lease Finance is going to pay
you the principal plus your last interest payment as long as they are still in business
and as long as they are still able to.
A lot of people think that bonds are guaranteed.
They are not actually guaranteed by anyone other than the issuer of the bond and it does
happen sometimes that bonds default.
That’s not the topic of our discussion today, I really just want t go through what the different
columns mean on this chart.
So let’s slide more to the right.
Now the next call refers to only bonds that are in fact callable.
What does that mean?
Sometimes the issuer has the right to call the bond early.
In this case, if the bond is due in May of 2013, if it was callable, it might be able
to be called let’s say in May of 2012 in which case the company could give you back
all of your money plus your final interest payment before the actual maturity date.
Being that this bond is not callable, it says here NC.
Now before I explain what estimated yield to worse and estimated yield to maturity mean,
let me go over to estimated price.
The prices that you’re seeing here and the yields are all as of April of 2012, so the
numbers obviously when you are watching this video would have changed though the principal
will still remain the same.
One thing you have to realize of course with any investment is that there are real risks,
so before you buy anything here, make sure you check with your advisor.
Everything you see here is simply for illustrative purposes, this is clearly not a recommendation
for any individual, each person’s situation has to be evaluated on its own.
So I wanted to cut to the column called estimated price.
Bonds are priced as a percentage of par value.
So the par value or the maturity value of a bond, the $1000 a bond – in this case
you’re buying 25 bonds, you get that $25,000.
If you pay 102.391, what does that mean?
It means that you’re going to pay 102.391% of a thousand.
So the easy way to calculate that is just move the decimal point over to one place and
you would pay for every thousand dollar bond $123.91.
You would only get back a thousand dollars, meaning you would be losing the $239.
You would know that in advance, this is called buying a premium bond and now that leads us
to this column estimated yield to maturity.
If you know that you’re going to lose the $239, why would you buy the bond?
The answer is because this bond pay the coupon of 5.78%.
So we use a bond calculator to calculate how much you’re going to lose and we add in
how much you’re going to make on the coupon rate and discover that the yield to maturity
meaning the ultimate yield that the client is going to make is about 3.5%.
If the bond was callable which this one isn’t then the yield to worse would potentially
be lower and now would be disclosed to you.
The annual income is the actual math where if you would buy 25 of these bonds, that would
be $25,000 worth, if you got 5.875% on this bond, you would get paid $1468.75 per year
which is exactly what this chart is showing you.
The total cost for you to purchase this $25,000 bond would be about $26,000 so you’re paying
a premium for it, you only get back $25,000 and again that’s because it’s the higher
coupon bond than you could normally get in the marketplace.
Okay, this was a brief summary of how to read the last page of the bond chart that perhaps
your advisor is sending you.
I chose to start with the last page because I wanted to look at how you can examine how
different bonds specifically are priced and what the different terms mean.
In the next episode of the series, we’re going to talk about some of the other summary
points related to bonds.
I hope you’ll join me there.
If you have any questions, please feel free to send me an email to doug@profile-financial.com
and if you want to learn a lot more about investing, check out our website, www.profilefinancialacademy.com.
Thanks so much.