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 Post subject: Thoughts on Investments
PostPosted: Tue May 08, 2012 4:55 pm 

Joined: Fri Mar 16, 2012 7:33 am
Posts: 107
I'm interested in some thoughts on a unique investment that I currently own. I have yet to draw a conclusion myself.

In the summer of 2008 I bought some 100 year bonds that were selling at a deep discount. They are actually quarterly interest bonds (QUIBS), with a 6.875% coupon and a $25 par value that mature around around the year 2100. I know, they look like preferreds...but trust me, they are bonds (trade on the NYSE).

I paid $7 per bond ($709.99 total with commission for 100 bonds) and they are now trading close to par, at or just below $25. The interest yield on my cost is about 25%.

So, what to do now? I can hold the bonds for the next 90 years and collect my coupons, and in the year 2100 walk away with a cool $2,500. At which point...may be only enough to fill my car with fuel. What is the right way to look at this? I guarantee that I will not beat 25% on my investments over the long term. But, based on the current value I might beat 6.875%.


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 Post subject: Re: Thoughts on Investments
PostPosted: Tue May 08, 2012 9:48 pm 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
Forget yield on cost. It means nothing. You are making 6.875%.

So you have $2500 or so tied up in bonds? What percentage of your portfolio is that (you don't have to answer, but if it is low, is it even worth worrying about it?) Of course, $2500 is $2500 and I wouldn't turn my nose up at it. 6.875% coupon is pretty good. But, it doesn't tell the whole story. What is the default risk (are these greek bonds)? If interest rates rise, what does that do to the value? junior or senior priority? convertible? so on and so forth.

If they are causing you heart burn, sell them and buy something that doesn't cause you heart burn.

_________________
Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: Thoughts on Investments
PostPosted: Wed May 09, 2012 6:05 am 

Joined: Fri Mar 16, 2012 7:33 am
Posts: 107
Why don't you like yield on cost? I am curious. I like it, but am open to reasons why I shouldn't.

As a % of my portfolio, it is very low...it doesn't keep me up at night.

They are the bonds of a bond guarantee company, which before 2008 was AAA. I'm not worried about default anytime in the next 10+ years. In 90 years...probably. They are not convertible, non-callable.

This morning I was thinking that I purchased them as a "special situation / workout" type of investment. I knew the company was going to survive and it was only at $7 because of forced sellers and total panic. The 25% yield at the time also helped. Now, it is back to par and while I'll continue to collect my 6.875% coupons for the next 90 years the price of the bond only has downside risk.

I can easily take my $2,500 now and investment in great companies yielding over 3% with the potential for dividend growth and capital gains.


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 Post subject: Re: Thoughts on Investments
PostPosted: Wed May 09, 2012 6:44 am 
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Posts: 5387
I'm with Bichon.

What you paid does not really matter. What matters is how any decision you make can affect you now. Today you have two options to compare: Keeping the bonds or selling them. If you sell them then presumably you will invest the proceeds elsewhere. The comparison then is whatever you could get elsewhere vs what you get now.

Holding: You get 6.875% of $2500 each year, effectively for life. That's taxable at a ordinary income rates every year.

Selling: You get about $2500 to invest (or spend) but you pay CG tax on $18 of that. You took a risk buying these bonds so this is clearly part of your risk portfolio. That means a fair comparison is probably going to be stocks and I think 6.875% is a reasonable expectation for stocks going forward.

I'm not so sure what I'd do. Holding seems pretty attractive but the growth prospects are slim. You'd need to be happy with the coupon.

Are these the Norfolk Southern bonds?


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 Post subject: Re: Thoughts on Investments
PostPosted: Wed May 09, 2012 8:52 am 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
Yield on cost is not a real return going forward. I've made clear my feelings on it, but some people still find some utility in the metric. And there may be some truth to that. For instance, YOC vs act yield can indicate the growth of the income over time. Here are two articles showing each side, you can decide for yourself. But know, going forward, you are not making your YOC, you are making the actual yield.

http://seekingalpha.com/article/310396-is-yield-on-cost-really-important-to-dividend-investors

edit: they'll only let me post one URL. to be continued.

I think since it is such a small part of the portfolio, does it really matter what you do? If want to be in equities, be in equities. If you don't like paying taxes as ordinary income, make a change. If it truly is a small part of your portfolio, it really won't matter in the long run. I could handle the 6.875% pre-tax return and would just let it ride if I felt default risk is low. But, it's your money, so you get to decide what to do.

_________________
Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: Thoughts on Investments
PostPosted: Wed May 09, 2012 1:45 pm 
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Bichon Frise wrote:
I think since it is such a small part of the portfolio, does it really matter what you do? If want to be in equities, be in equities. If you don't like paying taxes as ordinary income, make a change. If it truly is a small part of your portfolio, it really won't matter in the long run. I could handle the 6.875% pre-tax return and would just let it ride if I felt default risk is low. But, it's your money, so you get to decide what to do.


Yeah. I generally agree with what you are saying. But for discussion purposes...

It really matters what these are. If we are talking about the 100 year Norfolk Southern bonds then I'd note a couple of things:

1. At least in theory, stock valuation is based on the assumption that all companies eventually go bankrupt and hence have zero final value. All valuation is based on the return (dividends paid) to investors prior to that eventuality. Those dividends are uncertain and depend on the company's ability to earn a profit. (Or alternatively, under the "greater fool" theory, the value is what an investor can get an even greater fool investor to pay later).

2. Bond valuation is based on the discounted value of the coupon payments. But the ability to actually pay those coupons depends on the company's ability to earn a profit.

This means that the underlying risk of either a very long term bond or an equity investment are based on the same fundamental variable - corporate profitability. There fore, those bonds should behave like equities. That's in fact what history shows! (For shorter term bonds, even out to a decade or two, there is additional value in the claim on assets and the visibility of profits.)

The point is, I'm not sure I'd treat these as bonds. I think I'd consider them equities in terms of risk, much like a preferred stock without some of the features. I might also view them like a utility stock. Major railroads face no real long term threat in terms of hauling freight so I don't see them going away. Individual companies might run into trouble but the value of their track is pretty sound. They are much like a utility with a monopoly in a certain area.


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 Post subject: Re: Thoughts on Investments
PostPosted: Wed May 09, 2012 2:20 pm 

Joined: Fri Mar 16, 2012 7:33 am
Posts: 107
They are Assured Guaranty bonds (I own the b and e series).


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 Post subject: Re: Thoughts on Investments
PostPosted: Wed May 09, 2012 3:02 pm 
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I think I'd be hitting the "payout" button!

While I'd stick by most of what I said above, the increase in the shares of these bonds is because of improving municipal balance sheets. I'm not so optimistic that that trend will continue.

If it were me I think I'd be looking for the exits. You got lucky.


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 Post subject: Re: Thoughts on Investments
PostPosted: Wed May 09, 2012 4:51 pm 

Joined: Fri Mar 16, 2012 7:33 am
Posts: 107
I think I have reached the same conclusion as well.

1) The initial thesis for investing has been realized
2) There is little upside potential and substantial downside risk
3) My $18 in capital gains represents over 10 years of future coupons
4) Potential for greater returns with other investments

Thanks for the discussion.

Edit: sold this morning over par.


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