Income on individual bonds

aroominyork

I have asked a lot about bond funds in the past but want to check I understand how individual bonds work.

[FONT=&quot]Take Prudential 6 7/8% 2023 (LSE: BC41) as an example. Its price shows as buy £122.00, sell £126.10. Perhaps that wide spread in an out of hours situation which will narrow when the market opens?[/FONT]

[FONT=&quot]They were issued at 99.499 per cent, call it 99.5.[/FONT]
[FONT=&quot]They will pay 6 7/8% in arrears on 20 January each year.[/FONT]
[FONT=&quot]They will be redeemed on 20 January 2023.[/FONT]

[FONT=&quot]So, I buy a bond now for £126.10.[/FONT]
[FONT=&quot]On 20 January 2019, 2020, 2021, 2022 and 2023 I will be paid £99.50 x 6 7/8%, ie £6.840625.[/FONT]
[FONT=&quot]On 20 January 2023 I will also receive the £100 redemption value.[/FONT]

[FONT=&quot]Is that correct? Especially, am I paid interest in 2023, and is the interest paid on the issue price of £99.50 rather than on £100?[/FONT]

[FONT=&quot]If that is all correct, and excluding transaction fees, for my £126.10 I will, by 20 January 2023, have received £134.20, ie I will have made 6.42% (total, not pa) on my money, assuming Prudential continues to exist and can pay the bond, over a period of nearly five years?[/FONT]

Tom99

[FONT=Verdana, sans-serif]Yes you will get 5 interest payments, based on £100 I think not £99.50.

[/FONT] [FONT=Verdana, sans-serif]Assuming the buy price is still £126.1 when the market opens you will pay slightly more than £126.1 because you also have to pay the seller the accrued interest from 20th Jan 2018 until the day you buy.

[/FONT] [FONT=Verdana, sans-serif]You are right the gross redemption yield is very low, maybe just over 1% pa. Its a grade A bond so very low risk.

[/FONT] [FONT=Verdana, sans-serif]The buy/sell spread on individual corporate bonds is always a lot higher than say FTSE100 shares.

Depending on the platform you are using you may have to deal over the phone rather than live online.

Also you will not be able to buy that bond in an ISA as it has just under 5 years until it matures.
[/FONT]

bowlhead99

Tom99 wrote: »

[FONT=Verdana, sans-serif]
Also you will not be able to buy that bond in an ISA as it has just under 5 years until it matures.
[/FONT]

Actually the rules about not allowing short-dated bonds in ISAs were removed for assets you're acquiring inside the ISA on or after 1 July 2014. That was the time they bought int the ruleset that made ISAs generally more flexible (including being able to transfer S&S ISAs to cash ISAs and vice versa).

In 'the old days' the S&S allowance was bigger than the cash allowance and they didn't want you 'getting around it' by using S&S allowances to invest in super safe short maturity debt which was near-cash in its creditworthiness. But since 2014 that has been kicked away as a quirk of history and you can now put the whole £20k in Cash ISA or an S&S ISA in short dated bonds or near-cash assets (as long as they are qualifying assets, the maturity date is not an issue).

Tom99

Thats interesting to know bowlhead99. I bought bonds a few years ago choosing those with just over 5 years to maturity for the reason you outline.

bowlhead99

No longer need to worry about that - see section 7 of the ISA manager's guidance book https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/603261/ISA_Lifetime_ISA.pdf

Thrugelmir

aroominyork wrote: »

Its price shows as buy £122.00, sell £126.10.

You've quoted the buy and sell prices the wrong way round.

grey_gym_sock

Tom99 wrote: »

[FONT=Verdana, sans-serif]Yes you will get 5 interest payments, based on £100 I think not £99.50.

[/FONT] [FONT=Verdana, sans-serif]Assuming the buy price is still £126.1 when the market opens you will pay slightly more than £126.1 because you also have to pay the seller the accrued interest from 20th Jan 2018 until the day you buy.[/FONT]

agreed.

aroominyork wrote: »

[FONT=&quot]If that is all correct, and excluding transaction fees, for my £126.10 I will, by 20 January 2023, have received £134.20, ie I will have made 6.42% (total, not pa) on my money, assuming Prudential continues to exist and can pay the bond, over a period of nearly five years?[/FONT]

which slightly alters those number, but they're still approximately right.

note that it is even worse if you're paying tax on interest (i.e. if you don't buy it in an ISA or SIPP, and if you've used up the various allowances / zero-rate bands for interest).

because you pay tax not on the £8 overall gain you've made on your initial £126, but on the £34 interest you've received (though you can deduct the interest you pay the seller from this). at 20% tax, that would wipe out most of your (already small) profit. at 40% tax, you'd make a loss after tax.

also, your capital loss of £26 can't be used for purposes of capital gains tax (to set against capital gains). because individual bonds are (subject to various conditions, which i'm guessing this bond would match) exempt from capital gains tax.

on the plus side, that means that any capital gains you make from individual bonds are tax-free. e.g. think of the person selling the bond to you, who may have bought it at the issue price.

on average, you are quite likely to make capital gains by buying bonds at issue (or at close to the issue price) and selling them when they are much nearer to maturity. because generally, a 10-year bond will pay higher interest rate than (say) a 2-year bond.

however, there are several reasons why this might fail to happen:
1) interest rates generally might rise
2) the yield curve could be temporarily "inverted" (e.g. 2-year bonds might pay higher rates than 10-year bonds)
3) the ability of the issuer of the bond to pay might have become more doubtful

aroominyork

Tom99 wrote: »

[FONT=Verdana, sans-serif]Assuming the buy price is still £126.1 when the market opens you will pay slightly more than £126.1 because you also have to pay the seller the accrued interest from 20th Jan 2018 until the day you buy.[/FONT]

So there is no ex-dividend adjustment in price for bonds and the seller gets the income accrued since the previous interest date? How and when is that accrued outgoing shown to the buyer during the buying process?

Tom99

aroominyork wrote: »

So there is no ex-dividend adjustment is price for bonds and the seller gets the income accrued since the previous interest date? How and when is that accrued outgoing shown to the buyer during the buying process?

I am with Halifax and you can't buy corp bonds online, only over the phone. I got a buy price then a separate accrued interest amount and total, then x seconds to make a decision just like buying shares.

[FONT=Verdana, sans-serif]This was several years ago when bond yields were higher and the cash ISA limit was a fraction of the S&S ISA limit.

[/FONT] [FONT=Verdana, sans-serif]I don't think it would make much sense for an individual to invest in short term grade A bonds at the moment. If gross redemption yields are 1%-2% you can get a better rate on cash.[/FONT]

grey_gym_sock

Tom99 wrote: »

[FONT=Verdana, sans-serif]I don't think it would make much sense for an individual to invest in short term grade A bonds at the moment. If gross redemption yields are 1%-2% you can get a better rate on cash.[/FONT]

agreed. i think there may be a point in buying bonds which are less highly rated, or longer-term, or both. i have some money in such bonds. this would certainly not be suitable for all investors.

i'm not sure if aroominyork is contemplating buying individual bonds, or just trying to understand them better.

IMHO, it can be helpful in investing to have an understanding at a level of detail a bit beyond what you actually use in your own portfolio. for 1 thing, because if you apply everything you know, then the next time you learn something new, you'll have to change your portfolio to use what you've learnt! and frequent changes of strategy tend to yield poor results.

bowlhead99

grey_gym_sock wrote: »

IMHO, it can be helpful in investing to have an understanding at a level of detail a bit beyond what you actually use in your own portfolio. for 1 thing, because if you apply everything you know, then the next time you learn something new, you'll have to change your portfolio to use what you've learnt! and frequent changes of strategy tend to yield poor results.

+1 on that