Lose Money on a Secondary Market CD with a Positive YTM?

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Topic Author
krazykat
Posts: 2
Joined: Mon May 03, 2021 4:08 pm

Lose Money on a Secondary Market CD with a Positive YTM?

Post by krazykat »

I am exploring secondary market CD's. I've done a lot of research and built some spreadsheets but am still puzzled by 1) YTM and 2) value after taxes. In this case:

Trade Date: 3/24/21
Settlement Date: 3/26/21
Maturity: 2/14/22
CD Rate: 1.7%, paid semi-annually
Price: $101.176 (CD price premium plus Fidelity commission)
Qty: 4,000 (or 4-$1,000 CD's)
Accrued Interest: $7.64
Total Paid: $4,054.68

YTM per Fidelity is 0.375%, YIELD function per Excel is 0.374%.

If I understand correctly, I will receive $34 ($4,000 x 1.7% / 2) on 8/14/21 and 2/14/22, plus the $4,000 on 2/14/22. So I spent $4,054.58 on 3/26/21 to have $4,068 by 2/14/22, a difference of $13.32.

QUESTION 1: Doesn't that mean my "real" yield to maturity is $13.32/$4,054.58 = 0.329%, not 0.374%? Why are the numbers different? (If I wanted to compare it to something that would yield 0.35% in the same time period, how would I know which is better? The YTM doesn't seem reliable.)

Continuing the example, I believe the taxable interest amount is $60.36 ($68 - $7.64 accrued). (Ignore the fact that it's split over two tax years.) In the 24% tax bracket, that's $14,49,

QUESTION 2: Doesn't that mean that I am LOSING money on this CD with a positive YTM? I invested $4,054.68 but will only have $4,053.51 ($4,068.00-$14.49) after taxes. Am I missing something? I could instead invest in a money market earning next to nothing and still come out ahead. (Maybe the price premium just doesn't justify the CD Rate in a higher tax bracket? In which case there is definitely more than YTM to consider when purchasing secondary CD's.)

It seems like rather than relying on the stated YTM, I would be better off building a spreadsheet and doing my own calculations. Is my reasoning sound or am I missing something?
trueblueky
Posts: 2080
Joined: Tue May 27, 2014 3:50 pm

Re: Lose Money on a Secondary Market CD with a Positive YTM?

Post by trueblueky »

If you pay $4,054.68 and get $4,000 at the end, that $54.68 should show as bond premium on the 1099-Int. You'll receive $4068, so you have $13.32 taxable interest. Being spread over two years complicates it a bit.

This may show on Schedule B as:
CD interest. $68
Less bond premium. $55


https://www.irs.gov/pub/irs-pdf/i1099int.pdf has details.
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retired@50
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Location: Living in the U.S.A.

Re: Lose Money on a Secondary Market CD with a Positive YTM?

Post by retired@50 »

Welcome to the forum. :happy

If I were you, I'd start shopping for CDs at Ally bank.

Regards,
This is one person's opinion. Nothing more.
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alpenglow
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Re: Lose Money on a Secondary Market CD with a Positive YTM?

Post by alpenglow »

retired@50 wrote: Mon May 03, 2021 8:25 pm Welcome to the forum. :happy

If I were you, I'd start shopping for CDs at Ally bank.

Regards,
Secondary CDs were a great deal for a while. Now, not so much.
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#Cruncher
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Re: Lose Money on a Secondary Market CD with a Positive YTM?

Post by #Cruncher »

krazykat wrote: Mon May 03, 2021 4:24 pmQUESTION 1: Doesn't that mean my "real" yield to maturity is $13.32/$4,054.58 = 0.329%, not 0.374%?
No, the 0.374% is correct. Yield to Maturity (YTM) is annualized. Your investment does grow about 0.329%. But it does so in less than one year. Here is what your investment would look like if the time from settlement to maturity was exactly one year. Using Excel's XIRR function, we calculate a return of 0.330%, almost identical to your 0.329%. Columns D & E show the income and balance in a hypothetical savings account with the same 0.330% APY.

Code: Select all

Row      Col A      Col B  Col C   Col D     Col E
                 Cash Flow  Days  Income   Balance  Selected Formulas
                ----------  ----  ------  --------  -----------------
  2  2/14/2021  (4,054.68)                4,054.68
  3  8/14/2021      34.00    181    6.63  4,027.31  D3: =E2*((1+B$5)^(C3/365)-1)
  4  2/14/2022   4,034.00    184    6.69      0.00  E4: =E3-B4+D4
                             ---   -----
  5       XIRR      0.330%   365   13.32            B5: =XIRR(B2:B4,A2:A4)
Now here is what it looks like with the actual settlement date 325 days before maturity. XIRR now produces a return of 0.371%, close to the 0.374% produced by the YIELD function. [*]

Code: Select all

Row      Col A      Col B  Col C   Col D     Col E
                 Cash Flow  Days  Income   Balance  Selected Formulas
                ----------  ----  ------  --------  -----------------
  2  3/26/2021  (4,054.68)                4,054.68
  3  8/14/2021      34.00    141    5.80  4,026.48  D3: =E2*((1+B$5)^(C3/365)-1)
  4  2/14/2022   4,034.00    184    7.52      0.00  E4: =E3-B4+D4
                             ---   -----
  5       XIRR     0.371%    325   13.32            B5: =XIRR(B2:B4,A2:A4)
trueblueky wrote: Mon May 03, 2021 8:23 pmIf you pay $4,054.68 and get $4,000 at the end, that $54.68 should show as bond premium on the 1099-Int.
To be picky, $7.64 of the $54.68 is accrued interest; only $47.04 (4000 * 101.176% - 4000) is bond premium. But both of these can be deducted to determine net taxable income:

Code: Select all

 68.00  2 interest payments
 -7.64  accrued interest
-47.04  bond premium
------
 13.32  net taxable income
* 0.374% = YIELD(DATE(2021, 3, 26), DATE(2022, 2, 14), 1.7%, 101.176, 100, 2, 1)
Topic Author
krazykat
Posts: 2
Joined: Mon May 03, 2021 4:08 pm

Re: Lose Money on a Secondary Market CD with a Positive YTM?

Post by krazykat »

Ah! I didn't realize that YIELD/YTM is annualized. The XIRR example was very helpful. And while I knew that the accrued interest amount could be deducted, I didn't realize the same was true for the premium (but it makes sense). Thank you all!
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