In Your Best Interest. W. H. (Hank) Cunningham

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winning strategies, how to find and choose an IA, the mathematics of bonds, the concept of duration, how to forecast interest rates, bonds for the speculator, retirement planning (RRSPs and RRIFs), reinvestment risk, preferred shares and bond mutual funds, and GICs versus individual fixed-income products. There are separate chapters for zero coupon bonds and for the laddered approach, as they represent the cornerstones for your retirement needs. In addition, there is an expanded section on real return bonds (RRBs) and an expanded products chapter, separating conventional bonds from structured products. As an added bonus, you will know which way bond prices go when interest rates fall! I should point out here that all the various terms that are explained within the body of the book are also defined in the glossary located on page 223 at the end of the book.

      Someone asked me the other day about how the bond market worked. I have been asked that question countless times, but this time, without a lot of forethought, I blurted out: “It is all about relationships.” After I said it, I realized that I had tripped over the most concise and accurate description of how the bond market actually functions: relationships. Your success in the fixed-income market will be directly related to your relationship with your IA. Therefore, I spend some time discussing how to find a suitable one. That IA must have an excellent relationship with the trading desk of his or her firm. And that trading desk must have a strong relationship with all the IAs of that firm, as well as with the various counterparties it trades with. Thus, I stress the value of finding that right IA, one who will provide you with a good financial relationship and who knows how to build a relationship with the bond-trading desk of his or her firm. You may not have to worry about this if you are simply opening an online trading account. Perhaps the best of all worlds is to find an IA with fixed-income expertise and combine that with an online account. This would offer you the flexibility you need to do it yourself.

      In addition — and this is vital to your understanding of the fixed-income markets — almost all bonds trade in relation to another bond. Most bonds do not trade every day, so they are priced in relation to a bond that does. You will discover that bond prices change all the time, all day long, as the actively traded bonds (dubbed “benchmarks”) change in price. Other factors that can affect your returns are the relationship between short-term yields and long-term yields (the “yield curve”), the yield relationship among developed countries, the relationship between supply and demand in the different sectors of the market, and the relationship between today’s prices and yields and historical prices. This, in turn, permits you to conduct technical analyses, which can be of great help in timing purchases and sales. I urge you to study all these relationships, as they are vital to understanding this gigantic, practically invisible market.

      In this book I will also share with you some of my personal thoughts, experiences, and anecdotes from a lifetime in the securities business. I have held a wide variety of positions, including research analyst, institutional bond trader, institutional salesman, zero coupon specialist, portfolio manager (for two prominent financial organizations, Standard Life and Investors Group), and global bond trader (for CIBC). Since 1988, I have built and managed three fixed-income trading departments (Dean Witter Canada, First Marathon Securities, and Blackmont Capital), whose mission was (and still is) the provision of competitive pricing on a complete array of fixed-income products combined with top-notch service to investment advisors and their individual clients. Since April 2009, I have been associated with Odlum Brown Limited as their fixed-income strategist, and I have found it to be rewarding to work with their investment advisors and clients to enhance their returns. I have also enjoyed my repeat engagements with BNN as they recognize the need and demand for education in the world of fixed-income.

      I will briefly explain the wholesale or institutional business and point out its relevance to the retail market for fixed-income securities; its dominance and structure go a long way in explaining why the retail fixed-income investor has difficulty finding good service and prices.

      Another important reason for this difficulty is the poor education of both IAs and their clients. I am a leading proponent of making fixed-income markets more visible or transparent to the investing public by electronically distributing a wealth of prices and offerings on an extensive array of constantly re-priced fixed-income products, solely with the retail investor in mind. (I use the term transparency to mean the ease with which individual investors can gain access to information and prices for fixed-income securities. Fixed-income trades would be reported post-trade for everyone to see.) These quotations are now made available through IAs or directly to private clients via electronic connection with various vendors such as GMarkets, Reuters, or Bloomberg. The larger investment dealers offer bonds online to their internal sales forces and their discount brokers via their own private legacy systems. In addition, CBID Perimeter (CBID) offers real-time quotes on a variety of government and corporate bonds on their website: www.canadianfixedincome.ca. In addition, www.canadianbondindices.com offers a wealth of information for individuals and www.canpxonline.com features live prices on benchmark bonds.

      There are several initiatives underway in the realm of transparency. The net result will be broader visibility and availability of real-time bond pricing for individuals. Also, these online systems come with tools to make it easier for individuals to implement their strategies. I will talk more about transparency later.

      Like all markets, the bond market is undergoing a transformation. With the return to deficits at all levels of government, there are a lot more government bonds to choose from. Corporations, on the other hand, have exhibited considerable discipline and have not had to use the bond market as frequently as before the recession. The result has been a considerable narrowing of the yield spread between government and corporate bonds, with the attendant superior performance of corporate bonds. The amount of money invested by individuals in Canada in fixed-income investments totals approximately $793 billion. Approximately 58 percent of this total is in GICs. Bond mutual funds amount to $106 billion, ETFs $11 billion, while investments in individual fixed-income products total $218 billion. It is my belief, and a central theme of this book, that a large percentage of this money will find its way into individual fixed-income products, which, combined with safety of principal, offer greater yield than do bank deposits and GICs. Simply put, bond mutual funds charge too much in fees and produce average returns with uncertain future value. GICs are too short-term for long-term planning and are illiquid. Individual bonds offer a defined income stream, a known future value, liquidity, plus the flexibility to accommodate individual circumstances.

      Now, let us begin the process of providing you with the information and tools to help you make financial decisions in your best interest.

      Chapter 1

      What Is a Bond, What Is the Bond Market, and How Does It All Work?

      What Is a Bond Anyway?

      A bond is a piece of paper (well, a computer blip these days) that “bonds” borrowers and lenders. The borrower rents money from the lender and agrees to pay a certain rate of interest for the rental, normally at pre-arranged times, typically every six months. Thus, a bond is the original amount of the loan plus a series of rental cheques or interest payments. Eventually, the lease is up and the landlord gets the property (capital) back and can re-lease it or hold on to it.

      Benchmark Bonds

      A benchmark bond is an actively traded bond that is used to determine the prices of less actively traded bonds. The media report benchmark prices so that the investing public can see the direction of bond prices. As well, issuers of new bonds use them as reference points to price their issues. The Bank of Canada regularly adds to existing benchmark issues at the key maturity dates: two, five, ten, and thirty years. This contributes to a smoothly functioning marketplace. Investment dealers also use these benchmark bonds to hedge market risk.

      Here is the anatomy of an actual

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