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Old 03-20-2008, 02:13 PM   #11
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Capital Gains with bonds.

When youíre looking to achieve capital gains with bonds, the government and government agency backed inverse floating rate bonds described in my last post are the best bonds I can think of. Due to the fact that the coupons on some of these bonds float up as much as 30% for every 1% that the fed lowers rates or down 30% for every 1% the Fed raises rates they have extreme price volatility. Once rates have gone up you can find some of these inverse floating rate bonds for as little as 50 cents on the dollar. If the fed lowers rates 1% the price could go from 50 cents on the dollar up to par, or 100 cents on the dollar, in a very short period of time. We have made capital gains plays with this strategy often earning investors 40 or 50% on their money in a matter of months. This can also be done with bonds that have lower levers than 30%. A lever is determined on a bond before its issue. When you invest in one of these bonds you will know exactly how much the coupon will move up or down when the Fed moves. Many times people who originally wanted to sell a bond for a capital gain decide to hold onto it rather than sell because the coupon is now so high. I am holding some of these that are yielding about 60% currently with a value of about 160 cents on the dollar. Since rates have already fallen this is a play that is off the table for now. On the next rate cycle, be sure to ask your financial advisor about this play before you decide to make it. The prices on these bonds are very sensitive and are affected by mere perceptions of inflation that could cause the fed to move rates. Another thing that will affect the outcome of these plays is whether we have a Democrat or Republican in the white house. Dems tend to raise a lot of tax revenue through capital gains. Republicans tax the hell out of us through other means. Iím not taking sides in politics, just stating the facts that will affect your investments.

Rules that give you protection

There are bonds out there that float inversely to where the Fed moves rates that have a floor as to how low the coupon can go. I use these bonds for individuals that are already retired. If you can get by on the income produced by these bonds when they are on their ďfloorĒ these would be an investment that might fit your style. When I find investors that like to buy high credit quality bonds that give them for example 6% fixed I tell them they should invest in a floor bond that will never pay them less than a 5% coupon but has the possibility of going up to 10 or 11% coupons if the Fed lowers rates. Many of my 5% floor bonds are currently sitting around 9% and will go up farther if the Fed continues to lower rates. Many of these bonds are issued by government agencies or the federal government and have the highest credit quality. Thus you have stable income from the floor, and you have the possibility of higher returns if the Fed lowers rates.

If you have any questions please feel free to ask them here. Iíll get something up on simple tax free bonds next week.
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Old 03-25-2008, 05:03 PM   #12
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After this I think we should all be over the erroneous myth that you canít get enormous returns on AAA rated bonds just as you can in the stock market. No, you canít make Google money, but how many of us were able to get into that at the right time. You can make very healthy returns, and you have a contractual agreement from the bond issuer to give you all of your money back when the bonds come to maturity. In the stock market you could make big money one month, and lose big money the next. No contract to return your initial investment.

Tax Free Municipal Bonds

There are many investors out there who pay no taxes on the majority of their retirement income. This is done with Tax free municipal bonds that weíll go over in this segment. The laws apply to tax free municipal bonds as follows. If you buy a tax free municipal bond that is issued by an issuer in your state of residence you pay no state or federal income tax. If you buy a bond issued by an issuer outside of your state you will pay no federal income tax, but you will have to pay state income tax. If you have no state income tax in your state then you have free reign as to where your bond issuer is located. Be careful, most but not all municipal bonds are tax free. Make sure your advisor checks.

There are two major types of municipal bonds: general obligation bonds, and revenue bonds. General obligation bonds are issued by issuers with taxing authority. The principal and interest payments on these bonds are made from tax dollars. Revenue bonds have principal and interest that is paid from revenues from a public use facility or infrastructure. If you buy coliseum bonds they would be revenue bonds. If you buy toll road bonds they would be paid for by the revenues from the tolls paid by drivers using that toll road. Revenue bonds generally give a slightly higher yield than general obligation bonds because they are perceived as slightly more risky due to the lack of taxing authority to back them. A municipal bond will hold the same rating as it insurer. You need to ask your financial advisor what the underlying credit quality of the issuer is. At this point in time many of the municipal bond insurers are having solvency problems because they decided to insure billions in sub-prime mortgage backed securities. You need to make sure that the underlying credit of the issuer is strong because you can no longer count on an insurer to cover a default on the municipalitiesí part. If you are looking for the strongest credit quality in municipal bonds you would be looking for insured by Texas Permanent School Fund (PSF). PSF insured bonds are considered the strongest credit quality in the United States as far as municipal insurers are concerned. Unfortunately if you live in a state that has a state income tax you will have to pay your stateís income tax on PSF bonds, or move to Texas.

If you are in one of the higher tax brackets, these bonds make sense for many people who seek strong credit and a reliable source of interest checks. Hereís how to find out if a tax free bond will give you a better yield than a taxable one.

Tax Equivalent yield = Yield / (1 - your tax bracket)

If you are in a lower tax bracket you will be better off investing in taxable bonds and giving Uncle Sam his cut. Tax free bonds will generally give a lower interest rate than a taxable bond of the same credit quality and maturity. Their after tax yield will many times be higher to an individual who is in a high tax bracket after taxes are paid on the taxable bond. Use the formula above to find out if theyíre right for you and as always talk to your financial advisor before you invest in anything. If you have any questions please feel free to ask them here.
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Old 04-09-2008, 05:04 PM   #13
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Here's a blog posting by Eddy Elfenbein I found on long term returns on bonds vs stocks. This guy is just comparing a group of long term corporate bonds to stocks. I'd be willing to bet that he's not using any of the higher yielding higher credit quality government and government agency backed derivative bonds. If we look at the Dow as a whole, we have no return since 2000. The nasdaq as a whole is at a loss since 2000.

Eddy's post:


April 9, 2008 Stocks Against Bonds I recently received the latest Ibbotson Yearbook in the mail the other day. If youíre not familiar with it, the book is a great source for long-term returns of different asset classes (click here for more info).

What I find interesting is that the spread between the returns of stocks and bonds really isnít that much. I think would surprise many investors that boring bonds have held their own. Over the last 40 years, stocks have beaten bonds by a final score 10.5% to 8.4%.

The difference is theoretically due to greater risk for stocks. (Note: This is different from the usual equity risk premium which looks at stocks versus T-bills. Here Iím looking at stocks and long-term corporate bonds.)

Hereís a chart I made of stocks and long-term corporate bonds. The only difference is that I stretched out the bond returns by 2% a year.



These two lines have tracked each other remarkably closely. In the 1970s, bonds took a big lead over stocks, and in the late 1990s, stocks shot ahead of bonds. Besides that, itís been pretty close. You can also see that the market rally of the 1980s really wasnít much of a bubble, nor is today's market out of whack by historical standards.

Let me add that I do not think this is a good way to time the market.



Posted by edelfenbein at April 9, 2008 1:31 PM





Copyright © 2008 Eddy Elfenbein | Design by Callisto Design Studio | Hosting by InvestorPlace Blogs
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Old 04-18-2008, 02:29 PM   #14
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Structured CDs and Notes

Everyone knows that we can go to our bank and buy a CD that will give us 3 Ė 4% depending on how long we want to have our money invested and from which bank we buy the CD. What most of us donít know is that we can buy an FDIC insured CD that will give us 7 Ė 8% as long as the 30 year treasury is greater than the 10 year treasury. Most of these CDs will accrue interest on the days the 30 year is greater than the 10 year and not on the days that they are inverted. If we look at the number of days in the last 15 years that weíve had an inversion from the 10 year to the 30 year we can see that itís hardly enough to affect our overall annual yields. This is, of course, not something that you would want to throw your entire income producing retirement savings into. If you did throw all of your eggs into 1 basket and the 10 year to 30 year did go inverted for a long period of time, you could end up with no income. This is a great way to get full faith and credit of the U.S. government behind an investment that will give you 7 Ė 8% on money set aside for growth. There are many structures available in CD form that will give you a higher coupon than those you see at the bank. Ask your investment advisor about them.

Structured notes are a little different. We donít have full faith and credit of the U.S. government behind them, we have to look at the credit quality of the issuer. There are plenty of AAA rated issuers that will give you a nice rate. An investor can buy these notes linked to many different indexes, commodities, and stocks. If you believe that the price of corn is going to go up over the next 5 years, you might be able to find a note that is linked to the price of corn. For example: The investor invests in 5 year corn linked notes, the price of corn goes up 50% and the investor gets 150% of their initial investment at the end of 5 years. If the price falls by 50% the investor gets 100% of their money back at the end of 5 years. Itís a good way to get some of the upside in different commodities, markets, and indexes while you get the protection of a bond behind the investment. If you want to invest in commodities and are a bit apprehensive about the possibility of losing money this might be something you might want to try. As always before you make any investment, speak with your advisor first. Be carful with notes. There are many AAA rated issuers and many junk issuers. If the underlying commodity, index, or stock goes up and the junk rated issuer goes broke you will lose your money. Make sure you stick with the issuers who have the higher credit ratings.
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Old 04-21-2008, 10:26 AM   #15
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Thanks Bond Broker1 This thread has certainaly been educational for me.
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Old 04-21-2008, 02:47 PM   #16
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I'm Glad to know it's helping people.
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Old 04-21-2008, 10:52 PM   #17
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Back in the day I took the series 52 license test...man that is one tough test, first try 69 next time 88, but when it came to the Series 7 I made a 100% on the bonds section....
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Old 04-22-2008, 12:43 PM   #18
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BondBroker,

Within Texas municipals, I prefer PSF over the insurers as well. I believe PSF is 3x covered by the oil reserves, mostly in west Tx. I've never had a muni default, but I assume the PSF would kick in to cover in the same way a solvent insurer would, correct?

I was taught AAA, AAA rating, A or better underlying rating, GO bonds versus Revenue, and try to avoid hospitals, prisons and nuke plants. Sound like a reasonable short guage for screening munis?
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Old 04-22-2008, 01:18 PM   #19
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Flatscat,

PSF is definitely some of the strongest credit quality out there when it comes to bond insurance. AMBAC, FGIC, and most of the other municipal bond insurers out there made a big mistake and decided to insure sub prime mortgage-backed bonds and this was a huge mistake. They are now in danger of becoming financially insolvent. I donít really think that we would want to say that PSF would kick in the same way a solvent insurer would. Many of the private insurers have not paid a claim on defaulting municipalities even when they were in good financial condition. GO bonds versus the revenue bonds are definitely seen as safer but there are some strong revenue bonds out there. Large toll road authorities are usually viewed as safe revenue bond investments. You are right about the underlying credit. Since the insurers (except for PSF) are most likely not going to pay you in the case of default the underlying credit score is very important. I see airport bonds all the time that are CCC rated, Iíd say youíre right about that, Washington power supply had bonds on a nuclear plant default in the 80ís, and Iíve never looked at a prison bond. One more thing you might want to look at if youíre looking for safety in municipal bonds is bonds that are pre-refunded. This means that the money to pay the principal has been set aside. Very difficult for a bond to default when the issuer already has the money to pay the debt.
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Old 06-02-2008, 04:41 PM   #20
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Building a bond ladder

A bond ladder is an investment strategy that is used to attempt to keep cash flow and income at a certain level rather than subjecting the investor to a large degree of reinvestment risk. If an investor has $100,000 to invest in a bond ladder they would invest it in many different maturities rather than one single maturity. If an investor invests in one bond that matures in 5 years giving them 5% interest they may find themselves having to invest the money at a lower rate in the future if prevailing market rates have gone down. When building a bond ladder they may invest in a series of bonds that would stager the maturities out over a number of years. $100,000 may be invested in 10 different maturities that will give them an over all 5%. The investor may invest in one $10,000 dollar face amount that is one year to maturity and another at 3 years. The rest of the ten $10,000 increments could be invested in maturities that are 5 years and out. This way if prevailing rates are down from where they were when the initial investment was made they will only have to invest $10,000 at a lower level instead of the entire $100,000. Chances are, they will be able to invest other $10,000 increments at higher levels in the future when they come to maturity.

Another reason for using a bond ladder is it allows us to adjust cash flows to meet our financial needs. We can guarantee our monthly income based on monthly interest paid to us by the bonds. When doing this we need to not only pay attention to the maturities of the bonds that we put into our ladder but also the payment dates. This is very important to retired individuals that are dependant on the income from their bond ladder. We want to have a payment every month.

When creating a bond ladder we need to take the total amount we want to invest in bonds and divide it by the number of years we want to go out until maturity. This will give us the number of bonds (rungs) we will need in our ladder. The more rungs we have in our ladder the better diversified we will be. The amount of time between maturities or distance between the rungs can range from monthly to every couple of years.

The longer you make your ladder the higher your average yield should be but the more reinvestment risk you will have. If you make your rungs too small your return will be smaller but you have better liquidity.

Bond ladders can be made of many types of bonds. Some are made from municipal bonds giving investors tax free income. If the amount you have saved wonít put you in a higher tax bracket, then you should go with treasury, government agency, or corporate bonds with good credit ratings. I would not make a ladder that is too long out of corporate bonds because their ratings change. You never know when a company might go broke and leave you with a ladder that is missing a rung. Itís better to stick with government backed securities, muni bonds or even CDs.

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