Conservative bond strategy

[esculapius1975]

Hi All ,

I am quite new to the finance world and I would like your opinion on the following idea for a conservative investment.
If I invest on 5-10 different AA-BBB grade US corporate bonds with the aim of buy and hold to maturity choosing the ones that have a ratio between YTM and months to maturity > 0.5 (i.e YTM 1.5% and expires in 3 months, 3% for 6 months and so on) developing a mini ladder with the longest maturity at 2 years will this be an effective strategy to get at least a gross 6% return per year without taking significant risks for the intial investment?

Considering that interactive brokers offers the possibility of buying corporate investment grade bonds on 50% margin would this be feasible to leverage the position 2:1 and make a bigger profit considering that the interest rate on the margin should be 1.7%?

With a leverage 2:1 am I right to believe that I will get a margin call the only if value of the entire bond portfolio will drop at 50% or less?

Since the currency of my investment would be EUR would you think I could open a long position on the pair EUR/USD to offset the currency risks?

I have been thinking for a few days on this and I do not see any particular weakness but I believe an expert eye could find some.

I hope you can help.

Thanks

G.

 

[esculapius1975]

Nobody can help? Please.............

 

[Martinghoul]

How are you able to realistically expect 6% return on this, again?

 

[esculapius1975]

If I pick only bonds with at least YTM/months to maturity > 0.5%/month (i.e. 1.5% and maturity 3 month, there are many investment bonds with these values).

0.5% x 12 months = 6% p.a.

 

[esculapius1975]

If I pick only bonds with at least YTM/months to maturity > 0.5%/month (i.e. 1.5% and maturity 3 month, there are many investment bonds with these values).

0.5% x 12 months = 6% p.a.

Am I wrong?

 

[Martinghoul]

Am I wrong?

Well, money market rates in the US are, basically, arnd 0 (20bps O/N, 44bps 3M LIBOR, etc). As far as I am able to tell (see here: Composite Bond Rates: Bonds Center - Yahoo! Finance), a 2yr A-rated average corp bond yield is arnd 80bps.

So I, for one, am struggling to see how you intend to do this. Indeed, even before we got into the details, what on Earth makes you think that there's a straightforward strategy in USD fixed income/credit that allows you to earn a return that is, give or take, 600 basis points higher than the prevailing rate? I am not sure whether that should be classified as an honest mistake, willful ignorance or astonishing arrogance. You tell me.

 

[esculapius1975]

I did not mean to upset you.
Just give a look to the figure. Could not this be the list for the first 9 months?
Including the BBB the list is longer.

 

[esculapius1975]

This could be the list with the BBB

At the maturity of the first bond after less than a month the list would be updated and a new bond could be bought to replace the matured one with a similar or higher ytm/month rate.

 

[esculapius1975]

I agree that there are a very few bonds that fulfill the criteria over thousands and thousands but with these and continuing the ladder with similar bonds and keeping the ytm/month at 0.5 or more all the time should you not make 6% p.a. before leveraging 2:1?

 

[esculapius1975]

Hi Martinghoul,

I hope you or anyone else experienced in the forum could review that table and tell me what you think. It could be honest mistake or willful ignorance (not arrogance), but I would like to understand what is wrong in the calculations, or if there is anything else I am not taking into account that makes the whole thing a nonsense.

Thank you in advance

G.

 

[Martinghoul]

Sure thing... I am not upset and I appreciate that you're not being arrogant about it, but are rather just trying to understand.

I have looked at some of these bonds. Firstly, what you see isn't going to be exactly what you get. Specifically, some of these issues aren't really tradable in the open mkt and therefore the yields you're seeing aren't real. Secondly, have you noticed that all of these are financials? There's a reason for that. Thirdly, have you read through the prospectuses (prospecti?) for these issues? They all look like senior unsecured, but you need to be sure. Ofen the specific entity of the issuer makes all the difference in the world. Finally, you need to be aware of the specific stories arnd some of these issuers (e.g. Eksportfinans), since sometimes the rating doesn't really reflect the issuers credit accurately.

In general, if I were you, I'd start with the assumption that the yields you're observing are too good to be true and then try to figure out why that might be the case. If you have exhausted all the possibilities and haven't found anything "wrong", you can cautiously get involved.

If you want me to try and dig into one of these specific bonds with someone who trades this type of paper (I don't do corps), pick one and I will try to help.

 

[esculapius1975]

Thank you for the answer.
I think I have made some mistake doing calculations.
Can you just confirm this: YTM should be the annualized return of a bond including the bond price (if is sold at discount or premium).
Is this suggesting that a bond with a ytm of 6% and maturing in only 2 months should produce 6/12*2=1% of the investment over two months accounting for the coupon plus the difference to the market price-the redeem price of the bond. Is this correct?
If this is correct how can be that if we consider the following real example

Merrill Lynch co trading at 103.16, Coupon 6.150, Maturity 25/04/2013 has a YTM calculated on the yahoo bond screener at 3.809?

If I buy this bond today and hold till maturity I will hold it for 260 days.
The fraction of coupon I will get will be 6.150/360*260= 4.41
Having invested 103.16 I will be given back at maturity 100 so will be -3.16
4.41-3.16 = 1.25 in 260 days
1.25/260*360 = 1.73% per annum whereas it should be 3.809% according to yahoo

Where am I wrong in these calculations? and most importantly how much would I get back in the real world if I buy today the bond?

 

[Martinghoul]

Yes, YTM is always given on an annualized basis, regardless of the frequency of the actual coupons, and it's the rate of return on a security, assuming you're holding it to maturity. And yes, your logic is correct.

As to your specific example, I am not really sure where Yahoo is getting the 3.809 number. With the price of 103.16, I am seeing a yield of arnd 1.555, which is (very roughly) in line with the number you have calculated.

To get an idea of the cashflows, let's take a simple case where you buy the bond on the 24th of October 2012 for settlement on the 25th of October 2012. In this case, there's no accrued interest and, let's imagine, you will pay 103 exactly. On 25th of April 2013, you will be paid back the principal of 100, as well as the last semi-annual coupon of 3.075, so a total of 103.075. Does that make sense?

 

[esculapius1975]

Thank you very much for your explanation