AAII Journal Editor
Bond Basics: The Many Meanings of Yield
Consider both yield and total return when analyzing bonds.
How to Make Money From Bonds
The yield curve and the direction of interest rates impact your profit.
AAII Discussion Boards
Do you invest in callable or convertible bonds?
This week’s AAII Sentiment Survey results:
Bullish: 52.3%, up 8.4 points
Neutral: 23.4%, down 5.3 points
Bearish: 24.3%, down 3.1 points
January 17, 2013
January 10, 2013
January 3, 2013
December 20, 2012
December 13, 2012
December 6, 2012
November 29, 2012
November 22, 2012
November 15, 2012
November 8, 2012
November 1, 2012
October 25, 2012
October 18, 2012
October 11, 2012
October 4, 2012
September 27, 2012
September 20, 2012
September 13, 2012
September 6, 2012
August 30, 2012
August 23, 2012
August 16, 2012
August 9, 2012
August 2, 2012
July 26, 2012
July 19, 2012
July 12, 2012
July 5, 2012
One alternative source of income you may not be familiar with is exchange-traded debt (ETD). Also referred to as preferred equity traded (PET) bonds, these are debt instruments that trade like stocks. Like any other investment vehicle, they have unique risks that should be considered before purchase.
ETDs are debentures, notes and bonds. Unlike traditional bonds, which trade on the bond markets and are listed by CUSIP numbers, ETDs trade on stock exchanges and are listed by ticker symbols, just like stocks are. ETDs have par values of $25, instead of the typical $1,000 par value bonds are issued with. You can trade an ETD through an online broker just as you would a stock.
Though they trade like stocks, ETDs pay interest, not dividends. This means the coupon payments are taxable at ordinary income rates, not the discounted 15%/20% tax rate qualified dividends are eligible for. The coupon payments are made quarterly, where as traditional American bonds pay interest on a semiannual basis.
ETDs are callable. This means the issuer can repurchase the security at a preset price after a certain date. When I scanned the 155 ETDs listed on Quantum Online, most seemed to be callable five years after issuance at the par price. Once the five-year anniversary date is passed, the issuer can buy back the ETD for $25, regardless of what its current market price is. A few can also be converted into common stock, if specific conditions are met. These features limit the upside for an ETD. These features should also give you caution about paying a premium.
Because these are debt instruments, their prices are impacted by interest rate changes. All but six ETDs listed on Quantum Online pay fixed rates of interest, so when interest rates finally do rise, the prices of these securities will decline. The possibility of being called should provide some cushion, but won’t prevent prices from falling. The interest rates on ETDs are higher than on many bonds, with coupon rates ranging from 4.5% to 9.5%. The higher coupon rates reflect both the longer maturities and the possibility that the ETDs could be called at par value ($25 per share) prior to maturity.
Credit ratings vary and so do prices. Goldman Sachs Group 6.125% notes due 11/1/2060 (GSF) have an A3/A- credit rating, but closed at $26.43 today. This price represents a 5.7% premium, essentially pricing in the one year of income paid by the security. PulteGroup Inc. 7.375% senior notes due 6/1/2046 (PHA) have a B1/BB- credit rating and trade for $25.45. This security can be currently called at the company’s discretion, which would explain the smaller premium. A few ETDs were categorized as being delisted, so pay attention to the exchange listings.
Seniority and maturity dates vary. Some ETDs are senior debt, even though the text on the Quantum Online website suggests otherwise. Others are subordinated, or junior, debt. In the event of bankruptcy, secured debtholders have priority, followed by senior debtholders and then subordinated debtholders. Similarly, some ETDs have maturity dates as short as seven years, while others are not set to mature for 60 years or longer.
If you are interested in learning more about a particular ETD, read the prospectus carefully. Quantum Online provides links to the prospectus for each security, though you will have to register to access the data. (The website is free; Quantum Online simply requires you to register.) Analyze the issuer’s financial strength before making a purchase. You want the issuer to be profitable, generate positive free cash flow and have a manageable level of debt. Finally, consider the ETD’s valuation; in today’s interest rate environment, upside is limited for many debt securities, so you will want to ensure that you don’t pay too high a price over par.
More on AAII.com
- Bond Basics: An Investor’s Guide to the Many Meanings of Yield – When analyzing a bond, you should look beyond yield and consider the potential total return.
- How to Make Money From Bonds – Both the shape of the yield curve and the direction of interest rate changes influence how you should adjust your bond strategy, as this article explains.
- Do you invest in callable or convertible bonds? – Tell us on the AAII.com discussion boards.
- Not a member? Join today.
The Week Ahead
More than 100 S&P 500 members will report earnings next week. Included in this group are Dow components Caterpillar (CAT) on Monday; Pfizer (PFE) on Tuesday; Boeing (BA) on Wednesday; and Chevron (CVX), Exxon Mobil (XOM) and Merck (MRK) on Friday.
The Federal Reserve will hold its first meeting of the year, starting on Tuesday. A statement will be released on Wednesday at approximately 2:15 p.m. ET.
The week’s first economic reports will be December durable goods orders and December pending home sales, both of which will be published on Monday. Tuesday will feature the Conference Board’s January consumer confidence index and the October Case-Shiller home price index. The first estimate of fourth-quarter GDP and the January ADP Employment Report will be released on Wednesday. Thursday will feature December personal income and spending and the January Chicago PMI. January jobs data that includes the change in nonfarm payrolls and the unemployment rate, the final University of Michigan January consumer confidence survey, the January ISM manufacturing survey and December construction spending will be published on Friday.
The Treasury Department will auction $35 billion of two-year notes on Monday, $35 billion of five-year notes on Tuesday and $29 billion of 7-year notes on Wednesday.
AAII Sentiment Survey
Bullish sentiment rose to its highest level in two years, while bearish sentiment fell to its lowest level in about a year in the latest AAII Sentiment Survey
Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 8.4 percentage points to 52.3%. The last time optimism was this high was January 13, 2011. This is also the eighth time in nine weeks that bullish sentiment is above its historical average of 39%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, plunged 5.3 percentage points to 23.4%. This is a seven-week low. It also puts neutral sentiment below its historical average of 30.5% for the 15th consecutive week and the 17th time in 19 weeks.
Bearish sentiment, expectations that stock prices will fall over the next six months, fell 3.1 percentage points to 24.3%. This is the lowest level of pessimism registered by our survey since February 9, 2012. It is also the sixth time in seven weeks that bearish sentiment is below its historical average of 30.5%.
Bullish sentiment is at an unusual, but not extraordinarily, high level. In statistical terms, optimism is more than one standard deviation above the historical average. A good start by stocks to the New Year, action by Congress to avert the fiscal cliff and raise the debt ceiling (at least temporarily), continued economic growth, better-than-forecast fourth-quarter earnings and seasonality are all contributing to individual investors' optimistic moods.
This week’s special question asked AAII members what economic trends they are currently watching. Responses varied widely and several members listed more than one trend. U.S. fiscal policy, and the political fight over it, was named by the largest number of members. Employment data and housing data tied for second of the most mentioned data. These indicators were followed by interest rates and the direction of stock prices, which tied for third place.