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Can someone explain bond pricing?

Old 01-04-2008, 02:09 PM
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Default Can someone explain bond pricing?

Stocks are perfectly clear to me but bonds/treasuries??? I dunno. What are they talking about when they say bond prices are up, yields are such and such? What is supposed to make one happy, high price, high yield?
How to figure?
Thanks,
John Gov.
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Old 01-04-2008, 03:00 PM
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Default Re: Can someone explain bond pricing?

Here's the Wiki link to Bonds:

http://en.wikipedia.org/wiki/Bond_%28finance%29
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Old 01-04-2008, 04:33 PM
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Default Re: Can someone explain bond pricing?

When you buy a bond, you are lending money. You get compensated for lending this money by getting interest paid to you (usually twice a year.... called a coupon). Yield typically refers to Yield To Maturity. It is a measure of the interest rate you are earning should you hold the bond till it matures. Right now 10yr Government bonds are yielding about 3.85% for example.

Now pricing after the initial issuance...... price is inversely related to yield. If you have a bond you bought 18 months ago that paid 5%, and interest rates are now 4% (the market yield is lowered), your bond is worth more than it used to be, no? I mean you are getting paid 5% when the new bonds are paying 4%. Your bond is more valuable. If you wanted to sell it, you would sell it for more than the amount you lent (paid). If you lent it at price of par (100). your bond would be perhaps 101ish.

If interest rates should rise to 7%, then your bond's price would go down. Why would someone buy your 5% bond when they can get a brand spanking new 7% one? If you wanted to sell yours, you would sell it for less than 100 (par), perhaps at 97.5ish.

Today, I cant imagine why one would want to buy bond funds, or individual bonds. Interest rates are so low, it barely pays to hold them over cash. But bonds should be part of any balanced portfolio for sure. Today with the market down 300... and the Nasdaq down 100, If you held bonds instead of stocks, you are happy now. Especially government bonds.
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Old 01-04-2008, 04:36 PM
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Default Re: Can someone explain bond pricing?

If bond price goes up then yield drops. Same as a stock. The amount paid (interest/dividend) remains the same. Yield for the purchaser/owner does not change because when you buy you are in at a fixed price but yield changes for the prospective buyer.
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Old 01-04-2008, 05:10 PM
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Default RE: Can someone explain bond pricing?

So, the value of a bond is tied to the interest it paid when you bought it? It's a fixed rate. If I bought a $10,000 bond at 4% and now interest rates are 5% that means my $10,000 is worth less because you could buy a new $10,000 bond at 5%?
Where is the upside to bond investing?
john gov.
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Old 01-04-2008, 05:25 PM
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Default Re: Can someone explain bond pricing?

Upside is that practically speaking, there is less risk than with an equity investment over the long term. You also get a known yield, so they are good for people who want cash income. Another upside is as the other poster mentioned, when interest rates fall, the price of the bond rises, because the present value of the interest payments you receive and the principal that you will get back is worth relatively more. Finally, when the economy improves, the credit risk in corporate bonds will decrease, which puts downward pressure on the yield of the bond, and as a result the price will tend to increase.

Over long periods of time, bond returns will lag equity returns by a few percentage points, but over short periods of time, the differences can be significant in both directions.
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Old 01-04-2008, 06:38 PM
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Default RE: Can someone explain bond pricing?

john gov. - 1/4/2008 5:10 PM

So, the value of a bond is tied to the interest it paid when you bought it? It's a fixed rate. If I bought a $10,000 bond at 4% and now interest rates are 5% that means my $10,000 is worth less because you could buy a new $10,000 bond at 5%?
Where is the upside to bond investing?
john gov.
The others have done a great job explainin' the metrics n' pricin' of Bonds.

"Where is the upside to bond investing?"

"Upside" is they way I would talk about equity investin' not Bond investin' (with the exception of "Junk" bonds).

The best you can ever expect from a high quality bond purchased at par (100 which means 1000 per 1000 in face value), held to maturity is timely payments of interest, (which was competitive for the risk of the bond repayment cornsiderations at the time of original issue), and a return of yer money at maturity.

Inflation or taxes are big problems fer buy n' hold bond investors, but they desire predictable income n' predictable return of their money, that is why they bought a bond in the first place.

A low quality bond, (higher risk of payment of interest and principal), is referred to as a "Junk" bond if the S&P rating is less then BBB-. Those types of investments have an (equity level) rate of return, and can be home runs in some circumstances.

Bond mutual funds are a bit troublesome (especially since this summer) as the fund may have CDOs that are hard to value at this point in time.

If ya had the hair ta buy the 30 year 16 7/8 US Treasury Bond in the summer of 1981, (the highest coupon* ever on a 30 year Treasury, [*interest rate]), you would have made a greater return then the S & P 500 for most of the holding periods, n' the gravy train will end in 2011 if ya held it.

If ya bought a long term high quality AAA Muni or long Treasury in the mid 1970s, (when the interest rates and inflation went up dramatically in the late 1970s due to the wonderful job of Prez Jimmy Carter), the value of yer bond fell hard and never got back ta par 'till the early part of this millennia.

Joe Kennedy, (JKF's dad) went long Railroad bonds, (long term) in 1929 when he traded out of his long positions in stocks, (he also shorted stocks), in October (prior to the crash), that was the biggest home run possible as rates on long bonds went to 2.5% during the deflation of that period.

Hope this helps.

Respectfully, JR
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Old 01-05-2008, 08:13 AM
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Default RE: Can someone explain bond pricing?

OldMercsRule - 1/4/2008 5:38 PM

"Upside" is they way I would talk about equity investin' not Bond investin' (with the exception of "Junk" bonds).

Respectfully, JR
Hey JR,

Didn't you get the spin memo that the term "Junk Bonds" is not acceptable, and has been replaced by the term "High Yield"?


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Old 01-05-2008, 09:19 AM
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Default RE: Can someone explain bond pricing?

Snapper Head - 1/5/2008 8:13 AM

OldMercsRule - 1/4/2008 5:38 PM

"Upside" is they way I would talk about equity investin' not Bond investin' (with the exception of "Junk" bonds).

Respectfully, JR

Hey JR,

Didn't you get the spin memo that the term "Junk Bonds" is not acceptable, and has been replaced by the term "High Yield"?


Big Al
Yeah, I guess yer right, (only one functional brain cell n' all).

There is "High Yield" fer the touchy feeeeeely types n' "Trash Bonds" if the High Yields go away when the ol' HY Bond defaults.

Thanks fer the correction!! JR
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Old 01-05-2008, 09:44 AM
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Default Re: Can someone explain bond pricing?

The upside with bonds is a much smaller risk of a large drop in value than typically exists for equity investments.
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Old 01-05-2008, 10:20 AM
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Default Re: Can someone explain bond pricing?

SeaJay - 1/5/2008 9:44 AM

The upside with bonds is a much smaller risk of a large drop in value than typically exists for equity investments.
I guess this world is REALLY upside down these days, (especially the choice n' use of buzz words these days).

If we have trouble definin' what the word "is" is; or what a "lie" is, I guess slowly losin' yer money is a relative "upside" cornpared ta makin' money or losin' more in a much more attractive risk reward situation that domestic multi national equities generally represent fer long term investors most of the time.

If ya want predictable income and ya don't care about currency cornsiderations or many (time related while long the bond) inflation cornsiderations, ya can get predictable income and a return of yer diminished principal by acceptin' corntinuin' losses from the two factors stated herein.

Sometimes (at significant inflection points), ya can make a very risky trade n' have real "upside", (as I stated in me first post on this thread), [Joe Kennedy in 1929 or the 1981 long Treasury opportunity]. Those are very rare situations, (IMHO), and since we face both potential inflation and (fairly rare over time) potential deflation risks today, you could make a case fer a potential great trade in a long secure bond in a strong currency as havin' potential "upside" if the wheels totally fall off this gravy train and we get full fledged deflation, (which could happen).

Elect a Socialist n' nationalize a very productive self supportin' tax payin' part of the private sector, (health care), n' raise taxes ta support the HUGE Nanny Gubmint, (which will double in size when health Care is nationalized), if ya really want some good ol' fashioned deflation, n' depression n' despair. A surrender ta Islamo Fascists will help us hit the terlet real quick toooooooo, with a defeat that will likely bring the Muslim swords ta this Great Country again, (like 9/11).

Sorry fer the rant, you were jus' makin' a simple observation. Respectfully, JR
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Old 01-05-2008, 11:26 AM
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Default RE: Can someone explain bond pricing?

Uh, I think I'm confused again...more.
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Old 01-05-2008, 12:45 PM
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Default RE: Can someone explain bond pricing?

john gov. - 1/5/2008 11:26 AM

Uh, I think I'm confused again...more.
john gov.
Sorry: John; I may have caused that.

Bonds are where you loan your money to some entity for a set rate of interest and a set repayment date. Most bonds have $1,000 face amounts and semi annual interest payment dates. In the case of US Treasuries, (by far the largest issuer of debt instruments on the planet we all live on), debt instruments with an original maturity greater then ten years are "Bonds", less then ten years greater then one year are "Notes", and shorter then one year "Bills".

If you buy a "safe" bond and hold the bond to maternity you get the semi annual interest payments and yer money back at the end of the term.

If rates of interest for the length of yer particular bond you bought at $1,000. per bond (let's say ten of 'em fer $10,000) was 4% or $200.00 every six months. Lets say after ya bought the bond rates of interest for the exact same type of bond you have fell to 2% $100.00 every six months. Your bond would be worth more 'cause yer bond has twice the income at 4%. The longer the bond has to maturity the greater the movement in value (if you sold it rather then holding it). The opposite happens if rates go up. If a similar bond to yours was available at 8% or $400.00 every six months vs your $200.00 the market value of yer bond would fall to make the yield to a new investor the same as the new issue.

Cornclusions: If rates fall after ya buy ya could make money by selling the bond fer more then ya paid. If rates rise ya take a hit if ya sell the bond.

Inflation BAD fer existin' bond holders as more interest is necessary ta get anybody ta buy bonds.

Deflation GOOD fer existin' bond holders, (assumin' they are safe bonds).

Bonds rated less then BBB- are not "safe" and will generally trade on the perceived risk of repayment.

Hope that clarifies the mud I stirred up. PM me with a telephone # if ya need more, (non specific recommendation), explanation. Sorry I cornfused ya. ME=BAD. JR
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Old 01-05-2008, 07:28 PM
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Default Re: Can someone explain bond pricing?

Did anyone mention the tax free nature of some bonds??? Or the CPI over the maturity period?
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Old 01-05-2008, 07:33 PM
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Default RE: Can someone explain bond pricing?

Watch your duration if you think rates are going to go higher......and that's all I can say about that.
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Old 01-06-2008, 11:24 AM
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plugmeister - 1/5/2008 7:28 PM

Did anyone mention the tax free nature of some bonds??? Or the CPI over the maturity period?
Yeah, some Socialist states have income taxes, n' it should not be shockin' to people who get it that those same states need ta borrow lots of money fer NANNY GUBMINT stuff.

The State that I live, (WA), in doesn't have an income tax yet, (the dim wit Dems are tryin' real hard ta put one in). Here in GOD's Country they blow up perfectly good Domed Stadiums with brand new roofs on 'em n' build the most expensive twin stadiums money can buy against the wishes of the Socialist voters here n' dim wits promote the dim wit feller who did it ta the ol' Governor's office ta cause more damage (which he did). We can't possibly fix real important things like our bridges n' roads 'cause we have those NEEEEEEET stadiums fer Billionaire owners n' millionaire players ta have fun in. The Sonics are now movin' ta Oklahoma as the multi million dollar tax payer funded place we built fer 'em recently isn't good enough!! BTW glad the SeaChickens spanked the Skins in one of those neeeeeeeet new places yesterday!


That said: if ya buy a Muni bond, (generally exempt from most Fed taxes but the Feds bifurcated that deal too in 1986 n' made it real cornplex), the bond is generally exempt from the State's taxes where the bond was issued too in addition to most or all Federal income taxes.

Same cornsiderations about pricin' in Muni's too, (less liquid then Treasuries n' the bond insurance entities are havin' issues with the CDOs they insured), so that great Capitalist Warren Buffett is gettin' paid ta help out. Buffett is a Liberal who uses Capitialism ta get rich but preaches Socialism ta keep the rest of us down, (like many guilty Liberals do).

The flexible coupon CPI based bonds are interestin' as well. In fact there are lots of fancy stuff out there. CMOs n' CDOs were the rage when they first came out as well. My philosophy: KISS. KEEP IT SIMPLE STUPID. Moral of the story: If it is cornplacated ya better know every possible angle as someone out there sure does, n' will pick yer pocket if ya take a nap.

Respectfully, JR
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