Photo Credit: Flickr/Georg Schwalbach
A couple weeks ago, I wrote about the private investor and how not to get robbed when buying bonds. I promised that in a future post I would reveal a cheeky little trick we private bankers like to use when buying bonds for our clients portfolios. If you are expecting something evil and sinister, you will be gravely disappointed, because all it is is a bit of a deceptive innocent façade.
Bonds (the majority anyway) mature at what is known as par which is 100. During a bond’s lifetime, it can trade above or below par, depending on the interest rate situation and factors relevant to the underlying bond (in corporate bonds, it is the financial viability of the underlying company; in a sovereign bond, it is the current and future economic situation of the underlying country).
The thing is, if we have two bonds to choose from, which are of near equal yield, and one is trading above par and one is trading below par, which one do we always choose? We choose the one trading below par, each and every time. Why?
Because it looks good. Yes, that’s right. The reason is that it looks good. You’re still thinking “why,” aren’t you?
Look at it this way. When the client logs on to his or her account or receives the account statement, as time goes on and the bond approaches maturity, it will show a positive sign on the statement. Think about it. You buy a corporate bond trading at 90 with one year to maturity, provided the underlying company doesn’t go belly up during that year, and the price will continue to rise, ending at a 100 (par) on the maturity date when it is redeemed.
The private banker can then tell the client what a clever fellow he has been for having recommended that particular bond.
The more below par bonds bought for the portfolio, the more plus lines there will be on the client’s statement, and, psychologically, it is a brilliant booster and makes the banker look good and the client happy.
So there you have it. Nothing illegal, nothing nasty, just a plain little incy wincy trick used by all the experienced chaps in the trade.
Bonds (the majority anyway) mature at what is known as par which is 100. During a bond’s lifetime, it can trade above or below par, depending on the interest rate situation and factors relevant to the underlying bond (in corporate bonds, it is the financial viability of the underlying company; in a sovereign bond, it is the current and future economic situation of the underlying country).
The thing is, if we have two bonds to choose from, which are of near equal yield, and one is trading above par and one is trading below par, which one do we always choose? We choose the one trading below par, each and every time. Why?
Because it looks good. Yes, that’s right. The reason is that it looks good. You’re still thinking “why,” aren’t you?
Look at it this way. When the client logs on to his or her account or receives the account statement, as time goes on and the bond approaches maturity, it will show a positive sign on the statement. Think about it. You buy a corporate bond trading at 90 with one year to maturity, provided the underlying company doesn’t go belly up during that year, and the price will continue to rise, ending at a 100 (par) on the maturity date when it is redeemed.
The private banker can then tell the client what a clever fellow he has been for having recommended that particular bond.
The more below par bonds bought for the portfolio, the more plus lines there will be on the client’s statement, and, psychologically, it is a brilliant booster and makes the banker look good and the client happy.
So there you have it. Nothing illegal, nothing nasty, just a plain little incy wincy trick used by all the experienced chaps in the trade.
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