Forum Archive Index - June 2003

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Peter,
 
> Memo
>  Can someone help me with the calculation of the return or yield from
>  a capital notes purchase?
> 
> Details:
> 
> Face value $30,000 at 8.5% yield.
> 
> Total purchase cost is $30,351.70
> 
> Advised this includes $103.94 accrued interest plus $248.68 brokerage
> at a "net return" of 8.37%
> 
> No way can I make these figures add up.
> 
> If I subtract the accrued interest & the brokerage I get $29,998.64
> paid for a note that has a face value of $30,000 at 8.5%. Surely my
> return is greater than 8.5%??
> 
> How does this work?   What am I missing?
> 

You haven't given quite enough information here.   When is the 
maturity, or rollover date of this investment? 

How often is interest paid out?   How far away from the next 
payout date were you when you bought these 
capital notes?

Briefly, If you pay more than the face value for a capital note 
(or bond), this means that your return *must* be less than the face
 value yield rate ( 8.5% in this case).  In times of falling interest 
rates this is almost always the situation with capital notes.

Another point to remember is that if you hold this bond to maturity, 
the amount you will be repayed is only $30,000.    Since you paid
 $30,103.02 (brokerage fee removed), you will make a $103.02 loss 
on the principal portion of your investment.  This loss should be 
amortized out of the remaining life of this investment and will 
reduce your interest return.    Alternatively you can wait until the 
bond matures or you sell it, then claim your loss.

I note that 8.5% interest of $30,000 comes out to $2,550.00 per year.
Note that $2,550.00 on an 8.37% interest rate implies a bond value of 
$30,465.94.  Given that you only paid $30,103.02, it would seem you 
got a bargain.  Or did you?

There are a couple of things I am aware of that might be screwing up 
your calculations.

The bond yield calculator as used in the finance industry makes an 
assumption that all interest payments are able to be reinvested at 
the same yield.    Quite why this is so, when in reality for the small
 investor,  this is not the case  is something I do not understand.   
I am just relaying on to you what I was told happens!  

Is it possible that the figure of 'accrued interest' of $103.94 includes 
some  'interest on interest' that no small investor will ever get?   
That would mean the real   amount you paid for the bond is higher than 
the $30,103.02 that you quoted.  That still wouldn't account for all of 
the discrepancy though.

Also there is no tax allowed for in the finance industry standard 
calculator.  Tax is always taken out of a bond at the foundation interest 
rate, which in this case is 8.5%.  This means that although you have 
apparently bought this bond at a yield of 8.37%, the tax on any 
interest you receive will be taken out at source *assuming* you were 
earning the full 8.5%!  This is ultimately balanced out when the bond 
matures or you sell it and you claim your loss on the capital value of 
the bond.  I mention this only in passing as I don't think tax should 
be an issue in what you paid, but I guess it wouldn't hurt to ask?

Another thing I can think of is that maybe this capital note has a 
variable interest rate.    Maybe it is 8.5% for two years, whereupon 
the interest rate drops to 8.0%?    I know that sounds far fetched but 
some bonds are tied to prevailing government interest rates at the 
time and this sort of thing can happen.  This can also happen when 
capital notes have some kind of roll over provision at the end of 
their nominal life.

If you can understand all of that, and I'm not saying that I fully 
understand  all the implications myself  (even though I just wrote it) 
you might just get to the bottom of this thing.

Good luck, and please post back if you find the answer!

SNOOPY

PS  The complexity of the corporate bond market is one reason 
why I find the what I perceive as the no greater risk but higher returns 
of high yielding shares more attractive than (capital notes)/bonds!







--
Message sent by Snoopy 
on Pegasus Mail version 4.02
----------------------------------
"You can tell me I'm wrong twice, 
but that still only makes me wrong once."


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