Learning How to Get Paid
find the bonds that are the best choice and market, total return encompasses the overall
recommend you buy the bonds. This may impact of coupon interest as well as price
not strike you as a well-kept secret. But movements in the price of the bonds them-
through some digging and evaluation, tap- selves. Buying bonds earning interest and sell-
ping into the right countries or companies ing as yields fall is the real way to invest and
and the right bonds at the right time could win with bonds. And this is what we’ll do
fill your pockets with profits. together through The Yield Letter.
But before you start investing in the bond
market, let’s review the basics so that we’re all The Way of the Trade
on the same footing. Bonds trade on three characteristics in the
markets. The first is inflation, both now and
Bond Basics in the future. The idea is that if inflation falls,
Bonds are simply securities issued to bor- the current value of those future interest and
row money from investors. Issuers can be principal payments will be worth more, dri-
governments or corporations. Governments ving bond prices up. Expectations remain sub-
represent the core of the bond market both dued; this makes for lower inflation risk and
in the US and around the world—they bor- higher bond prices overall.
row to make up for revenue shortfalls or Next is the credit. The bond issuer,
fund large-scale projects. whether a government or a corporation, is
Corporations that need money to sustain the interest and principal payer. If the market
current operations as well as to expand their has a positive opinion of the issuer, backed
capabilities will issue bonds. A bond is com- up by strong credit history and a good issuer
posed of the principal owed and interest to rating, the yield commanded to buy the
be paid. Bonds range in maturities from a bond will be lower and less risky. As percep-
few months to many decades, with bills refer- tions of credit rise or fall, the issuer’s bonds
ring to maturities less than one year and will fall or rise in yield.
notes referring to maturities from one to 10 The Federal Reserve is making it harder for
years. But whatever the maturity, all can be companies and other issuers to fail, so credit
called bonds. expectations should improve, driving yields
When you buy a bond, you’re set to receive lower. And with cash aplenty and lenders eager,
principal at the maturity and interest (typically the probabilities of default are reduced in the
in the form of regular coupons) while you market for riskier bonds. This means less of a
hold the bond. Coupons are usually paid once premium in yield is going to be demanded.
a year, yet some markets including US Trea- Third—and most important in the market
surys pay investors semi-annually. now—is competition for assets. Bond issuers
In addition to bonds that pay coupons, have to compete against other issuers when they
there are also bonds that pay their interest at go to the market to borrow money and sell
maturity. These types of bonds are referred to bonds. In addition, from day one to the final
as zero-coupon bonds or strips. When you payment and maturity, bonds from various mar-
purchase this type of bond, you pay a fraction kets compete against other bonds as well as
of the maturity value of the bond with the dif- stocks, cash and other assets to attract investors.
ference between the purchase and maturity If stocks are performing well, bond yields
values being your interest. will tend to rise to attract more buyers. And if
For the uninitiated, the idea of buying cash or other alternatives become more entic-
bonds often is simply to buy and hold the ing, bonds can suffer as yields are driven
bond to maturity and clip the interest higher and prices fall.
coupons. But bonds are more; they can pro- In the bond market, the price and yield of
vide us returns that eclipse stocks. In the bond each issue move hand-in-hand. As yields fall,
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Learning How to Get Paid
prices rise, and as yields rise, prices fall. This In transitioning markets, it’s the bonds that
inverse relationship between price and yield lead the rest. As countries repair credit and
becomes more pronounced the longer the attack local inflationary pressures, bond
maturity of the bond. traders tend to notice, driving prices up and
Short-term bonds move much less than yields down. This allows companies to benefit
longer-term bonds. Fewer future cash payments from an emergence of available capital and a
are affected by the higher or lower yields for a reduction in funding costs. Then the broader
short-term bond and the effective discounting markets of equity stock can begin to reflect a
of the future cash flows to the bond’s present potential further turnaround.
value. The rule of thumb is the longer the Buying bonds of countries just as they’re
bond, the greater the price to yield changes. fixing past woes is a surefire way to profit
It’s important, when investing in the bond from economic turnarounds. All it takes is the
market, to look at these components that willingness to look beyond the stock market
drive bond yields and prices. In The Yield Let- and mistaken notions of bonds to capitalize on
ter, we’ll look at how inflation, credit and the power of positive change in bond markets
competition affect our recommended debt. around the world, while Wall Street is still
There’s more to the bond market than just peddling its lousy stocks
straight bonds. Whether it’s bond funds or In The Yield Letter, I’ll lead you down the
Income Deposit Securities (IDSes), which are path to investing in foreign bonds. Nations
composed of common stock and a bond, ranging from Korea to Mexico and even the
there’s a bounty from which to choose. In The US have bonds that pay 10 percent or more
Yield Letter, I’ll recommend and cover bonds, and should give you the opportunity to profit
bond funds, IDSes and more. from rising prices—giving you even greater
Another area we’ll look at in The Yield Let- Currency Concerns
ter is foreign bonds. Buying bonds around the Beyond the bond market itself, the cur-
world is like buying stocks, because bonds can rency that denominates the bond can also
be viewed as the country’s core assets. As issu- play a vital role. Governments around the
ing countries’ fundamental conditions improve world issue bonds in their own market, in
or falter, their bonds will most closely reflect their own currency, as well as in the global
their changing fortunes. bond market in other currencies. For bond
If a country’s government is faltering, the investors, currency can be a double-edged
falling tide of the economy will be a difficult sword, either adding or subtracting to bot-
environment for any company to remain tom-line profits.
buoyant, just as a rise in fortune will be sup- In the case of countries that are fixing their
portive for most commercial ventures. By economic and financial ills, investing in their
focusing on the bond market, investors can bonds can provide windfalls. In addition, as
hone in on the changing trends in the general bonds of such countries begin to reflect
marketplace for all assets. improving inflation and creditworthiness, the
Bonds are good barometers of a country’s countries’ currencies will also tend to reflect
condition because creditors are the most cau- the improving core economic fundamentals.
tious of investors. As creditors become more However, if conditions begin to deteriorate,
impressed with the fortunes of debtors, the the foreign exchange markets as well as the
interest rates commanded in the market for new bond traders will often quickly react by pun-
and existing bonds will fall. But when a hint of ishing the currency and the bonds.
concern enters the picture, the first signs of mar- Buying into economic reformations through
ket destruction come from the bond pits. the bond market can be accomplished through
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Learning How to Get Paid
local currency bonds and often in US dollars. stantial reserves. In addition, Korea had main-
Historically, there are many great examples of tained trade and financial surpluses with the
windfalls from using both strategies. In the rest of the world and had only two outstand-
1990s, many countries in Europe and Asia ing bonds that they could easily have made
began to awaken to the benefits of reformation. good on. Many bond traders were able to step
The results of their efforts rewarded farsighted inland and buy US dollar-denominated bonds
investors with huge returns. for pennies on the dollar, which are now trad-
One of the more memorable occurrences ing back above par and even at premium
was in the New Zealand bond market. In the prices. We’ll look further at these currency
’80s, the country had fallen into a period of opportunities in The Yield Letter.
poor fiscal and monetary management that
resulted in an outflow of capital, and even Mortgage Mavens
people, at an alarming rate. For the country to Another way investors use the bond market
fund its spending needs, the markets com- without even realizing it is through their home
manded yields in the high double digits. In mortgages. Mortgages are the chief means of
addition, with horrible economic conditions, providing money for individuals to purchase
foreign exchange traders sent the New homes in the US and around the world.
Zealand dollar to the depths of 40 cents. In the US, families go to mortgage lenders,
Faced with a crisis, the country restructured which can be finance companies or banks.
its government in numerous ways, including After the loan is made to purchase or re-
making each minister responsible by contract finance a home, it’s pooled together with
for specific objectives. The Governor of the other home mortgages and then the collection
Bank of New Zealand, for example, had to of pooled loans is sold to the market in the
keep inflation under 2 percent or face a breach form of a bond. We’ll look further at mort-
of contract. As a result, the country is now a gage companies and mortgage bonds that are
model of responsibility. worth capitalizing on in The Yield Letter.
Eventually, the markets noticed and drove These are only a few examples of various
the New Zealand dollar higher and higher in debt markets that present themselves each and
the ensuing years. Bond traders also saw the every year. Through this service, we’ll delve
monetary discipline driving inflation lower as into the markets that are already in motion and
well as the fiscal discipline resulting in improv- explore the ones that are about to take off.
ing credit conditions. Ultimately, yields were
driven down and prices soared. Ins and Outs
Even more recently, during the Asian eco- First, I’d like to welcome you to The Yield
nomic crisis, another country was under the gun Letter. I’m happy you’ve subscribed and will
resulting in a windfall in the making. Korea, one soon be unlocking untold profits through my
of the wealthiest nations in Asia, was pressured bond advice. Twice a month, you’ll receive
to reform as many of its regional neighbors— articles that focus on current happenings in
including Thailand, Indonesia and Malaysia— the bond market or aspects that are impor-
were facing economic reckonings. tant to you and your portfolio. Articles will
In 1998, the world was holding its breath as be published at www.yieldletter.com.com. I’ll
several countries in Asia and Europe were also keep you informed via regular Market
heading into crisis, making the bond market in Updates throughout the month.
Korea a tough place. Then, when Russia As part of your subscription, you’ll have
defaulted on its bonds, traders dumped access to two portfolio tables, the Taxable
Korean bonds in sympathy, which drove yields Portfolio and the Tax-Free Portfolio. Each
into the high double digits. will include specific recommendations. I’ll
All this happened despite the country’s sub- also cover popular debt securities in the
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Learning How to Get Paid
bond world that you may be holding. I’ll great deal of experience with US dollar,
update the portfolios on a regular basis with non-US dollar and non-US government,
actionable advice and details that are critical agency and corporate bonds. Contact Chris
for you to lock in big profits. at 800-926-4922 for help with your global
Make sure to check in regularly at bond needs.
www.yieldletter.com for Market Updates, Another former colleague of mine from
through which I’ll update you on bond mar- Mark Twain Bank is Mark Elmore, principle at
ket news and information regarding our Tahoe Fixed Income. Mark specializes in US
holdings. I’ll also use the Market Update bond with a focus on agencies, pass-throughs
section to alert you to breaking news regard- and collateralized mortgage obligations
ing portfolio holdings, and you’ll be notified (CMOs). Contact Mark at 775-852-3994.
via e-mail when such alerts are posted. My former mentor and bond rabbi at Mark
Together we’ll dive head first into the Twain Bank—Bill Stern—is a great source for
bond market, explore the various securities helping you with your bond broker needs.
available and reap the high potential He’s a principle at Stern Brothers and special-
rewards together. izes in mortgages, passthroughs, CMOs,
municipal bonds and corporate bonds with a
Bond Broker Directory concentration in the US markets. Contact Bill
Now that you’ve subscribed and will be at 314-727-5519.
receiving my bond advice and recommenda- Another broker who can execute your plays
tions, you need a broker who will execute in the housing market is Mark Verbeist. Mark
your trades. As part of your subscription to is a former colleague and trader of mine. He’s
The Yield Letter, I’m providing you access to a veteran trader in the industry, with expertise
some of my closest and long-time friends in on handling mortgage bonds, pass throughs
the bond broker industry. and GNMAs. He’s currently a bond trader at
First is Martin Truax, from Morgan Keegan. National Alliance Securities. You can reach
Martin and I have been long-time friends, and Mark at 877-680-6588.
I worked with him at Mark Twain Bank. He’s Furthermore, Fidelity Investments
a 30 year-plus veteran to the broker industry (www.fidelity.com) and Charles Schwab
and has been in the financial newsletter indus- (www.schwab.com) offer you bond trade ser-
try since it started. Contact Martin at 866- vices. Fidelity specializes in government, muni,
813-9911 for your bond brokerage needs. corporate, agency and some foreign bond
Next is Chris Gaffney. Chris was my part- issues. Schwab offers on- and offline trading in
ner at Mark Twain Bank. He’s now the vice the domestic and international bond markets.
president of Evertrade Direct Brokerage. Schwab clients can reach the dedicated trading
He’s a veteran to this industry and has a team at 888-621-4355.
Disclaimer: The information contained in this premium is current as of 08/10/07. For the most up-to-date advice and pricing, go to www.yieldletter.com or
check your latest issue of The Yield Letter.