I would appreciate recommendations for web sites or books with explanations on how to select individual municipal bonds for puchase. Most of my funds are with Vanguard. They offer a variety of state tax-free funds, but none for my state (NC). They do offer the ability to buy individual bonds through their brokerage arm.
I have a decent understanding of how bonds work (interest rates up, bonds down), but am not sure how to select an individual bond to purchase. I did a search of NC bonds at the Vanguard Order Desk and see terms that I'm not familiar with, such as "callable 07/10@100 - Extraordinary Calls" and "Sinking Fund 07/20@100". I understand what it means for a bond to be callable, but not the figures or what an Extraordinary call is. Since these are bonds on the secondary market, it is not as easy to sell them as with mutual funds. Is there a source that gives an indication of how often/likely a bond is to be called? That way, I could purchase a 30-year bond, with the hope that it would be called in 5 years (if I was looking for a
I have one callable CD (whose adjustable rate also happens to rise every 12 months, per a pre-set sequence), maturing in three years (the original term was 5.5 years). In hindsight, I regret purchasing it a bit. With more study (or someone flat-out pointed it out to me), I figured all the important flexibility belongs to the issuer. If rates rise, it's sitting pretty, because the rate on my CD is likely lower than contemporary rates. If rates drop, it can (and I think will), call the CD. The last six months of this CD will pay 6%. The one advantage of the CD so far is that it paid better than money market rates for the first year or so. Now it's paying 4.25%, which is less than what my Fidelity money market account pays, but still not awful. This of course is using some hindsight, so my regret at this purchase is far from total. But, being a little wiser now, it's far less likely I will buy callable bonds or CDs in the future.
OTOH, for people who are a lot older than I (who am
40-something), there might be a stronger argument for buying callable bonds and CDs.
I would not go out more than about 5 years with a bond or CD, because I tend to think history will repeat itself, and resources like the one below (see the interactive graphic) indicate that one gains very little going out beyond five years.
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I used to check bond offerings at Fidelity, but these days CDs are so similar in what they offer, I find it's not worth the slightly higher risk to buy a company bond.
Remember we are in a period of yield curve inversion right now. Things are a little whacko, with short term bonds (oddly, historically speaking) paying better than many longer term ones.
I plan to avoid secondary market bond and CD transactions. I buy with the intent of holding to maturity, since interest rates are somewhat more predictable, at least for the short term. I leave my "gambling" to my stock picks, selling if I don't like the fundamentals of a stock, and only selling at a gain (even if it's only a small one).
In the absence of taxes, one should buy or sell a stock based on its expected return as of today, which does NOT depend on the price originally paid. Someone who does not understand this basic principle of investing should not be advising others. In a taxable account, other things being equal, it usually makes more sense to sell stock on which one has losses.
I love it when someone takes a sound bite, dismisses the context (which was important here--you totally muffed the meaning), and assumes it is the last word. :-)
For the slower witted, my comments above (1) are nowhere near my entire counsel for when to sell a stock; and (2) do not apply to an awful lot of people, since I deal almost exclusively in large value stocks.
An excellent site is InvestingInBonds.com. Their learning section is at:
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07/10@100 means that the bond is callable July 2020 at 100 (par). Bond prices are generally quoted at 1/10 of their value - bonds with a face value of $1000 are quoted as 100. You need to know this when you place orders for bonds, because you may order, say, 5 bonds @99, meaning that you are buying
5 $1000 bonds at $990/bond.
Bonds are often callable at a premium. For instance, I've bought a muni bond with a par call 04/15/09, callable 04/15/07@101.00. That means that it may be called in 2009 at face value ($1000/bond), or in 2007 at a premium price ($1010/bond, or a 1% premium). Unlike CDs, callable bonds often have this feature that helps lessen the impact of getting called early.
You'll find a fairly good description of a sinking fund at:
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a sinking fund provision requires a bond issuer to buy back part of the issue periodically. So it is like a call, but partial and whether you are the lucky one who gets his bond bought back is pure chance.
A bond purchased at a premium is more likely to be called. There are bonds on the secondary market that carry high coupon rates. That higher rate creates demand for the bond, forcing up its price (and forcing down its yield); hence the premium on the price. So you are getting a fair yield on the bond, but from the issuer's perspective, it is paying an above market rate (the coupon rate). That makes it likely that the issuer will call the bond when it can.
Conversely, a bond purchased at a discount is less likely to be called.
Read the site, keep asking questions. One other thing to keep in mind about munis is that many (most?) of the AAA rated bonds are so rated because they are insured. Local governments with lower credit ratings find it is cheaper to pay for the insurance than it is to pay more on bonds that get issued at, say, AA ratings. So muni ratings may not reflect the credit worthiness of the issuer so much as the insurer. I don't think that's a big deal, but I think you should know what the rating means.
Finally, if you have a question about a particular bond, post the CUSIP. (The bond site I gave you provides a history of the buys and sells of the bond, by CUSIP, on the secondary market.)
This is true of any security, not just stocks. Specifically, since this thread is about bonds, one should mark to market, and not rely on face value. That gives the investor an accurate sense of the value of the investment, with which one can take appropriate action and not blithely hold to maturity.
I've done the occasional bond swap, because yield curves do not move in tandem - different parts of the curve move differently, and different curves (different grades, different types of bonds) also move differently. Fortunately, I'm working with a broker who keeps an eye out for this kind of opportunity.
Page describing swaps - what they are, why one would consider them, when one would consider them, etc:
perhaps a key point of holding individual bonds is that if you hold to maturity, then that is somewhat irrelevant to you-- you get the face value of the bond back at maturity.
(you do have risk there, the risk of what interest rate you get in reinvesting the coupons on the way, unless it is a stripped bond).
but am not sure how to select an individual bond to purchase. I did a
You'll need a glossary of bond terms
Frank Fabozzi Handbook of Fixed Income Securities is the standard reference book (but quite technical in parts). I don't know if there is a more convenient web based one.
Callable is usually bad news for investors-- see Swensen's book on personal investing. Essentially bonds are usually called if they go to a premium (coupon rate is above prevailing market interest rates). So the investor takes the downside (risk of the other way) and not the upside. For this reason, Swensen recommends a focus on US treasury securities (If I recall correctly the tax issue is one he talks about ie municipal tax frees).
The short answer is a bond will normally be called when it is disadvantageous to the holders, and advantageous to the issuer ie when interest rates are lower than at the time of bond issue. Although it sometimes doesn't happen, you should invest on the expectation that it does.
'Extraordinary Call' I don't know. Usually the issuing prospectus (at least for stocks, I don't know about bonds) has to be filed with the SEC (google Edgar) and that will tell you the terms of a call.
As another poster indicates, probably best to stick to non-callable AA rated municipal bonds or above. If insured, they may have a higher rating. My take on this (perhaps falsely) is that whilst the leading municipal bond insurer (MBIA?) *could* default, the impact on the financial system if it did so would be so large that the US government would have to do some sort of rescue operation.
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intro to the sector
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mutual fund holding NC exempt bonds (worth checking the holdings)
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offers some municipal bond closed end funds (for NC)
It takes a graduate degree in financial engineering to determine the fair yield spread of a callable bond over a noncallable bond of the same maturity. The banks issuing such callable CDs have the expertise, and individual investors do not. Individual investors do not see a two-sided market in callable bank CDs -- they can buy them, but they don't (at least I don't) see publicly quoted prices at which they can be sold. In general I recommend that individual investors avoid complicated products with one-sided markets. There is a two-sided market in corporate and (to some extent) municipal bonds, so any embedded optionality in them should be priced fairly. Even in those markets, a low-cost bond fund may be a better investment vehicle, because a fund can be better diversified and because in the bond market, unlike the stock market, the bid-ask spread can be higher for small order sizes.
I am not advocating callable bank CDs by any means, but most financial professionals CAN access both sides of the callable bank CD market. Most, if not all, broker/dealers give us access to them.
You are right in on both accounts in that individual investors cannot readily see this market and there is little if any benefit over munis, corps, and bond funds.
IMO, "expertise" is an overstatement. A formula exists for comparing that which is callable to that which is not, but you seem to be neglecting the assumptions on which such formulae exist. Pricing is fuzzy and mutable, not scientific.
What we can say IMO is that the parameters of CD prices are fewer than those of stock share prices, so they're an easier category of asset to understand.
Evaluation of assets such as stocks, CDs, bonds etc. is not engineering. Call it "finances."
The callable bank CD I have routinely has a price next to it when I look at my positions in my online brokerage account. It currently is less than the face value, since, for one, this callable CD yields less than comparable fixed CDs right now.
I'm with B on this one, I don't know why most retail investors would bother with individual munis. There are a few parts to the problem.
One is that the universe of munis is truly enormous. There's something like 50,000 issuers and 2 million separate issues out there. Compare this to stocks -- there are few hundred that most individual investors will bother with. There's free and readily-available information about any of these stocks and they're discussed regularly in the financial press. That's not at all the case with munis, there are simply too many issues out there. Now granted the analysis is different because defaults are almost nonexistent and a the decision is driven by interest rate considerations. But that's not a trivial thing to optimize. And I don't know how I'd assess call risk for an issue from a random county, given the information available to retail investors.
The next problem, also an extension of the market size, is that most bonds trade infrequently - every few weeks? Intel, by comparison, trades many times every second. So "market efficiency" arguments don't hold quite as well because there isn't enough trading for price discovery, to use some jargon.
And when you do trade you give up a lot more to transaction costs than with stocks. It puts some shackles on "portfolio optimizing" that the institutional manager doesn't have, to the same degree. An interview in a trade rag recently cited a figure of 3% to 5% of principal in each direction as being common for retail muni trades, until recently (I've seen that anecdotally as well). That's a whole year of yield given up...300 to 500 basis points of cost. That can pay for a lot of years of muni-mutual-fund management fees and incremental tax costs for using a multi-state fund.
There are now a few new bond markets, somewhat analogous to the ECNs that helped drive narrower spreads with stocks. Apparently the spreads have narrowed. But it's still an expensive security from a transactional standpoint. Here are the new web exchanges for munis, google should turn up links - they actually provide feeds to a bunch of public sites: Valubond BondDeskgroup TheMuniCenter
And here's a free site where you can look up daily bond trades, and the price history for a bond you hold or are interested in buying (enter the CUSIP:
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Given those 2 million issues you often don't see a recent trade, especially on older bonds.
Add all this up and there's a lot to be said for paying Vanguard -- what is it? -- 12 basis points annually to do this for you? Plus the state-tax hit. You might still end up ahead, and you'll certainly be more-diversified. I could easily see losing 50 to 100 basis points on execution in the individual-muni portfolio, more if you put a price on the time required to learn how to buy munis and research each issue (and keep up with them, to determine whether to replace any or not).
There is no formula for evaluating embedded call options in fixed income securities. Option Adjusted Spread (OAS) analysis is used for comparing callable and noncallable fixed income securities.
I typed out exactly that post, with that web link, and then deleted it. Partly because I thought on rereading her post that she might be referring to something much more specific.
But you are utterly correct 'Computational Finance' is also referred to as 'Financial Engineering'.
At least in London, FE also refers to any general restructuring of the corporate balance sheet eg via private equity. But that's a looser (sloppier) parlance.
The typical quant desk at an investment bank is *full* of Phds in physical sciences and engineering. Similarly MFE programmes normally require a quantitative undergraduate degree. Undergraduate degrees, even in Economics, in European and Asian universities typically have much more demanding mathematics content than US programmes. At the LSE for example, a US BA student wishing to read an economics masters typically has to do a preliminary year to bring his or her quant up to speed.
So I wouldn't understate the brains these investment banks command. They pay far more money than any science or engineering role, and they get the best people.
Unfortunately that is all working on the 'sell' side. There are clever people on the buy side, but a lot fewer of them. The ingenuity is present in markets but asymetrically.
I would recommend Frank Partnoy's 'FIASCO' for a (out of date) view of the world of derivative products (he worked for Morgan Stanley) and Nicholas Derman's 'Reflections of a Quant' for the story of a physical scientist in the 'rocket science' department of an investment bank.
======================================= MODERATOR'S COMMENT: Posters to this thread should relate comments to financial planning.
Many students in Master's programs in Financial Engineering do have Bachelor's degrees in math, physics, and engineering, and most "financial engineers" on Wall Street have a PhD in one of those subjects, as do I. A good financial engineer has advanced training in math, statistics, numerical analysis, and mathematical finance (portfolio optimization, derivatives pricing) and is able to program. As catalpa observed, pricing callable bonds fairly relative to noncallable bonds requires a nontrivial mathematical model. Such a model will have inputs that are not known with certainty -- in particular, the future volatility of interest rates -- but a financial engineer will be able to price a callable bond more accurately than a nonprofessional.
A term that is often used instead of "financial engineer" is "quant", short for quantitative (financial) analyst. A good introductory book on derivatives pricing is "Options, Futures, and other Derivatives" by John Hull, and the autobiography "My Life as a Quant: Reflections on Physics and Finance" by Emanuel Derman conveys the flavor of the field. Browsing those books would convince open-minded people that there is some substance in quantitative finance as a sub-field of finance.
Are you implying that OAS analysis is not formula based and not fraught with assumptions? Because it is. I sure hope you're not splitting hairs over the use of my word "formula."
One problem with mathematicians and the like becoming "financial engineers" is that they tend to think every set of numbers from the past denotes a useful pattern for the future. They often overlook uncertainties when putting numbers into the mill to grind out a conclusion--because just getting the conclusion is enough for them, incomplete as the latter actually is.
I continue to caution anyone from being intimidated by claims that only higher math enables a competent understanding of financial planning. That's simply false.
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