LIBOR/bond question

A corporation offers two bonds (3-yr and 5-yr) which, they say, are both based on the 6-month LIBOR rate at the time of issue "plus or minus a spread". The corporation insists that currently there is no spread. Yet the 3-yr annual interest rate is 5.1625%, and the

5-yr annual interest rate is 5.2125%.

Doesn't that mean that there **must** be a spread for at least one of those bonds; otherwise, wouldn't both bonds have the same interest rate because they are based on the same LIBOR rate? Or do I have a fundamental misunderstanding about how the interest rate is determined?

To be fair to the corporation, there is room for some miscommunication. Since I qualify only for the 3-yr bond (due to the minimum investment requirement), they might have meant that there is no spread only for the 3-yr bond.

But according to bankrate.com, the LIBOR rate for "the week" of Aug 1 is 5.33% (I don't know how they determined that since BBA LIBOR rates are set daily), and the bond rates quoted by the corporation are valid for Aug 1-7. I cannot find Aug BBA LIBOR rates. But looking at July, the largest variation is

0.0838 pct pts for the month. So it seems unlikely that 5.1625% is the current BBA LIBOR rate.

I would ask the bond sales rep. But I have already bothered her with so many nitpicky question that I am becoming a pest -- and honestly, I know I will invest in these bonds anyway. I feel guilty asking more question just for my edification. Moreover, she is inexperienced, so she must relay such questions to a "director".

I just want to know if I have a fundamental error in my understanding of how LIBOR rates are used, or if others agree that the corporation facts or numbers (or bankrate.com's ;-) seem fishy.

Reply to
nomail1983
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I mean to write: "and honestly, I know will __not__ invest in these bonds anyway".

Darn typos! I need a computer that will automatically enter the word "not" wherever I intended it :-).

Reply to
nomail1983

First of all, don't be afraid to ask the question of your salesperson. As someone that ran a bond trading desk for many years, I was on the other side of those questions (the "director" you refer to). A question on LIBOR would rank in the upper end of intelligent and relevant ones.

The only thing that is missing here some information, which is why you need to question your salesperson. I don't, however, think there is anything "fishy" here. The difference is tiny and the discrepancy is most likely due to incomplete information. I will assume from your posting that you are buying a retail investor-targeted bond (If you want my thoughts on that product, please email me directly). Since those bonds are generally priced once a week, a 3 and 5 yr bond with zero spread to LIBOR should have the same rate. But, something is missing. One thing is that the coupon is LIBOR flat (zero spread) but spread to swap rates is different. This would happen in a normal environment as an investor should be compensated with higher rate for a more risk (3yrs vs. 5yrs, among other things). The second is that the issues were repriced during the week. Given the volatility of the market, especially in the front end (short maturities) of the yield curve, this is a strong possibility. I suspect, however, that there is a miscommunication somewhere along the line. I don't know what company's bond you are buying, but I would guess that the 3yr was priced at LIBOR minus 1/8 (.125) and the 5yr was priced LIBOR minus .

075. The final possibility is that that the LIBOR rate they are using isn't a single number. There is a bid side to LIBOR, an offer (ask) and a mid point. They could be using one rate for one issue (say the offer for the 3yr) and another for the 5yr (say the bid side). Both could be LIBOR and yet have zero spread.

Hope this helps

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Reply to
bondguy1824

While none of this rivals particle physics in complexity, it's still pretty dense stuff. And as the thread starter demonstrates unless a fixed income investor really truly has it down cold he's always going to worry that he's not getting a fair deal. Moreover, the fixed income investor who buys invidual bonds has to figure this out for every last bond. Oh, and he needs to have enough bonds in his portfolio to be diversified.

Again, not impossible. But undeniably complex and time consuming. Why not just buy a fund that tracks the Shearson Lehman Aggregate Bond Index and be done with it?

Reply to
Paul Michael Brown

On Nov 3, 6:16 pm, snipped-for-privacy@his.com (Paul Michael Brown) wrot

Because the fees charged, even those charged by an index fund (which should be low because the fund manager is not adding any value) are too high. Unless you are referring to a small amount of money, funds rarely make sense over other options

Reply to
bondguy1824

Vanguard charges 0.11% - 11 basis points - on their ETF which tracks the Lehman Agg. Even if you could put together a portfolio which tracks it well, unless you had a huge heap of money, you'd probably come out spending way more than that on bid/ask spreads even assuming that your time and effort costs nothing. Good luck beating that. Their open-ended no-load share class of the same is 0.20% and their "admiral" shares for folks with > $50k to invest also charge 0.11%.

I guarantee you that when Vanguard or Fidelity executes a bond trade, they get a much better price than almost any individual when he trades the same bond.

FWIW: iShares recently started AGG, which also tracks the Agg, for 0.20%.

Fidelity's FBIDX charges 0.31%.

There are other reasons to go with individual bonds, especially if you are building, say, a treasury ladder.

But, no, it's awfully hard to beat 0.11% managing a diversified bond portfolio.

(And, btw, Lehman hasn't had "Shearson" in its name for a long time - since 1993)

Reply to
BreadWithSpam

I didn't want to nit pick about the Shearson thing...

Reply to
bondguy1824

My bad! Showing my age I guess.

It's still Merill, Lynch, Pierce, Fenner & Bean, right? ;-)

By the way, good point about the bid/ask spreads when purchasing individual bonds. For an investor, they can really drive up the expenses in a fixed income portfolio. Moreover, I think it's fair to say that transperancy is not ideal in the bond market and the little guy is at at significant disadvantage when he faces off against the Masters of the Universe. All in all, you're better of being Bogle and finding a low cost open end mutual fund or ETF.

Reply to
Paul Michael Brown

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