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From:  "tennyson@caverock.net.nz" <tennyson@caverock.net.nz> 
Date:  Mon, 30 Jun 2003 16:47:51 +1200 
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."  To remove yourself from this list, please use the form at http://www.sharechat.co.nz/chat/forum/
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