Purchasing an individual "baby bond"

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ilan1h
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Joined: Mon Oct 22, 2007 3:40 pm

Purchasing an individual "baby bond"

Post by ilan1h » Tue Jan 14, 2020 2:47 pm

I recently read an article regarding "baby bonds" that are issued in $25 denominations, are callable and have high coupon rates (5-8%). My goal would be to buy such a bond and then hold it to the point where it is called or beyond. My rationale is that this could be a fairly "safe investment" with a small risk of default. As an example, I looked at the Ford baby bond (F-C) which has a coupon of 6.0%. It trades for $26.30 ($1.30 above par) and is callable on 12/24. If they call this bond in 5 years it will have earned $7.50 in interest per bond (or $6.20 since I bought it above par). This translates to a yield of 4.72%/year. There is no 5 year CD that would yield anything close to this. If they call the bond, as scheduled, in 5 years I will have done well. If they don't call the bond there is a possibility I could continue to benefit for several more years until they call it.

The real risk, as I see it, is whether or not rates come up and the bond loses value. If that happens, they won't call the bond and I may be stuck with it. Based on the low interest rate environment that we are living in, it seems unlikely that rates will climb high enough within 5 years to really make this a losing proposition. Or maybe my analysis is wrong. Any advice would be appreciated.
Last edited by ilan1h on Tue Jan 14, 2020 4:51 pm, edited 1 time in total.

Church Lady
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Re: Purchasing an individual "baby bond"

Post by Church Lady » Tue Jan 14, 2020 4:48 pm

You are correct. Your best bet is to buy these securities right out of the gate before they are bid up. www.quantumonline.com isn't too bad, but sometimes I get a notification on my news feed before the same security is listed on quantumonline.

It's a fair amount of effort to monitor this site and research new offerings.

There are ETFs and funds that will do the work for you.
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity.

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Stinky
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Re: Purchasing an individual "baby bond"

Post by Stinky » Tue Jan 14, 2020 4:51 pm

ilan1h wrote:
Tue Jan 14, 2020 2:47 pm
Is my analysis correct in that there is no free lunch here? It really seems as if it's hard to make a decent return on these bonds unless the call date is deferred.
When dealing with knowledgeable counter parties, there rarely is a free lunch.

The issuer won’t defer the call date unless it’s in his financial interest to do so.
It's a GREAT day to be alive - Travis Tritt

anonsdca
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Re: Purchasing an individual "baby bond"

Post by anonsdca » Tue Jan 14, 2020 7:22 pm

ilan1h wrote:
Tue Jan 14, 2020 2:47 pm
I recently read an article regarding "baby bonds" that are issued in $25 denominations, are callable and have high coupon rates (5-8%). My goal would be to buy such a bond and then hold it to the point where it is called or beyond. My rationale is that this could be a fairly "safe investment" with a small risk of default. As an example, I looked at the Ford baby bond (F-C) which has a coupon of 6.0%. It trades for $26.30 ($1.30 above par) and is callable on 12/24. If they call this bond in 5 years it will have earned $7.50 in interest per bond (or $6.20 since I bought it above par). This translates to a yield of 4.72%/year. There is no 5 year CD that would yield anything close to this. If they call the bond, as scheduled, in 5 years I will have done well. If they don't call the bond there is a possibility I could continue to benefit for several more years until they call it.

The real risk, as I see it, is whether or not rates come up and the bond loses value. If that happens, they won't call the bond and I may be stuck with it. Based on the low interest rate environment that we are living in, it seems unlikely that rates will climb high enough within 5 years to really make this a losing proposition. Or maybe my analysis is wrong. Any advice would be appreciated.
Clearly, you understand this kind of bond. However, why buy $1.30, or 5.2% above its par value? You are just eating into the coupon rate (as you stated), so why not just find a similar baby bond you feel comfortable with at, near, or below par value. Then you could be juicing your yield, not eating into it?

Also, a CU in my state just finished offering a 13-Month CD at 4%, so it is possible. See the "Best CD Thread" for that topic.
Last edited by anonsdca on Tue Jan 14, 2020 7:27 pm, edited 1 time in total.

AZAttorney11
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Re: Purchasing an individual "baby bond"

Post by AZAttorney11 » Tue Jan 14, 2020 7:26 pm

ilan1h wrote:
Tue Jan 14, 2020 2:47 pm
I recently read an article regarding "baby bonds" that are issued in $25 denominations, are callable and have high coupon rates (5-8%). My goal would be to buy such a bond and then hold it to the point where it is called or beyond. My rationale is that this could be a fairly "safe investment" with a small risk of default. As an example, I looked at the Ford baby bond (F-C) which has a coupon of 6.0%. It trades for $26.30 ($1.30 above par) and is callable on 12/24. If they call this bond in 5 years it will have earned $7.50 in interest per bond (or $6.20 since I bought it above par). This translates to a yield of 4.72%/year. There is no 5 year CD that would yield anything close to this. If they call the bond, as scheduled, in 5 years I will have done well. If they don't call the bond there is a possibility I could continue to benefit for several more years until they call it.

The real risk, as I see it, is whether or not rates come up and the bond loses value. If that happens, they won't call the bond and I may be stuck with it. Based on the low interest rate environment that we are living in, it seems unlikely that rates will climb high enough within 5 years to really make this a losing proposition. Or maybe my analysis is wrong. Any advice would be appreciated.
The biggest risk is credit risk. Ford is not invincible. There's a reason those bonds have higher yields than many alternatives with similar duration.

not4me
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Re: Purchasing an individual "baby bond"

Post by not4me » Wed Jan 15, 2020 10:06 am

ilan1h wrote:
Tue Jan 14, 2020 2:47 pm
I recently read an article regarding "baby bonds" that are issued in $25 denominations, are callable and have high coupon rates (5-8%). My goal would be to buy such a bond and then hold it to the point where it is called or beyond. My rationale is that this could be a fairly "safe investment" with a small risk of default. As an example, I looked at the Ford baby bond (F-C) which has a coupon of 6.0%. It trades for $26.30 ($1.30 above par) and is callable on 12/24. If they call this bond in 5 years it will have earned $7.50 in interest per bond (or $6.20 since I bought it above par). This translates to a yield of 4.72%/year. There is no 5 year CD that would yield anything close to this. If they call the bond, as scheduled, in 5 years I will have done well. If they don't call the bond there is a possibility I could continue to benefit for several more years until they call it.

The real risk, as I see it, is whether or not rates come up and the bond loses value. If that happens, they won't call the bond and I may be stuck with it. Based on the low interest rate environment that we are living in, it seems unlikely that rates will climb high enough within 5 years to really make this a losing proposition. Or maybe my analysis is wrong. Any advice would be appreciated.
I'm not sure where some of your numbers came from & I underlined a couple of parts to expand on. It may be semantics, but just to be sure...

That particular issue is due to pay $1.5/year in interest regardless of price you pay -- so I guess the $6.20 came from assuming it would be called at $25 (& thus driving the yield number you quoted)? The $1.50 for a $26.30 bond would be about 5.7% pre-tax (check my math!!) for doing pre-tax compare. The call date doesn't mean they have scheduled a call at that point; it is the earliest they could call. They have no obligation to do so. They can then call it anytime after that until maturity in 2059.

You didn't mention if this was rated as investment grade or junk; not that far back Ford's regular bonds were rated by one agency anyway. I mention that to say interest rates aren't the only consideration. A credit downgrade would be another example. This is a new issue & it may be difficult to sell when you'd like & certainly price could go down giving you a loss. This being a new issue means you can't tell much about how liquid it is. Right now, you are probably buying from those who got in on initial issuance & are turning for a quick profit. The price isn't mathematically set -- it includes how much other investors are willing to buy.

I won't comment on your value judgments of "safe', "small risk of default", etc. This is an interesting example of the interesting times we are in. You can buy the Ford common stock & get a higher yield that will be taxed at (possibly) lower rates. The dividend is less safe than the coupon payment & stock price will be more volatile. But, the bond has minimal chance of capital appreciation & some chance of capital loss. The stock has some downside potential, but much more upside. So, when an investor is buying an individual issue, this is the dilemma -- am I getting compensated for the risk?

Topic Author
ilan1h
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Re: Purchasing an individual "baby bond"

Post by ilan1h » Wed Jan 15, 2020 8:01 pm

The reason why I arbitrarily chose Ford is that I'm not really in the position to evaluate or understand the credit worthiness of many of the other baby bonds on the list. Ford is a company that will still being around in 5 years. I find this to be a manageable risk. There are some other large, stable companies on the list (such as Ebay) but they're selling for even higher prices above par and/or call dates that are too close. Incidentally, someone asked why don't I just buy Ford stock? I think the obvious answer is that stocks (even Ford) can have tremendous downturns and volatility. However, a bond that's yielding over 5.5% is not going to start plummeting in value unless prevailing rates are approaching or exceeding that. And even then I would not expect rapid swings as one sees with the stock.
Last edited by ilan1h on Wed Jan 15, 2020 8:13 pm, edited 1 time in total.

anonsdca
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Re: Purchasing an individual "baby bond"

Post by anonsdca » Wed Jan 15, 2020 8:04 pm

ilan1h wrote:
Wed Jan 15, 2020 8:01 pm
The reason why I arbitrarily chose Ford is that I'm not really in the position to evaluate or understand the credit worthiness of many of the other baby bonds on the list. Ford is a company that probably has a 99.99% probability of still being around in 5 years. Therefore, the only real gamble here is whether or not rates rise to the point where the Ford bond no longer looks attractive. I find this to be a manageable risk. There are some other large, stable companies on the list (such as Ebay) but they're selling for even higher prices above par and/or call dates that are too close.
You are not going to be successful researching Baby Bonds here. You need to move on and look at other sources - and they exist.

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Stinky
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Re: Purchasing an individual "baby bond"

Post by Stinky » Wed Jan 15, 2020 8:57 pm

ilan1h wrote:
Wed Jan 15, 2020 8:01 pm
The reason why I arbitrarily chose Ford is that I'm not really in the position to evaluate or understand the credit worthiness of many of the other baby bonds on the list. Ford is a company that will still being around in 5 years. I find this to be a manageable risk.
It sounds like you’ve made your decision, and that you’re optimistic about Ford’s near term prospects.

Just be aware that Moody’s downgraded Ford debt to “junk bond” levels in September, citing weak cash flow. So that’s a good reason that the yields on Ford bonds are pretty attractive.

Best of luck to you.
It's a GREAT day to be alive - Travis Tritt

Ferdinand2014
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Re: Purchasing an individual "baby bond"

Post by Ferdinand2014 » Wed Jan 15, 2020 9:03 pm

My advise would be to not consider your proposed plan. You said it yourself:" I'm not really in the position to evaluate or understand the credit worthiness of many of the other baby bonds on the list."
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

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