What is a reasonable spread for bonds and other questions

[gaston]

Hi all,

Here are the yields for government of canada long bonds (from http://www.pfin.ca/canadianfixedincome/Default.aspx):



1. Can anybody explain why the yield on the 2064 issue is lower than the 2048 issue? Or why the yield on the 2045 issue is lower than the 2041? Is it a premium that investors are willing to pay for an increase in sensitivity? But if that is the case the 2048 at 1.95 does not seem to fit with that explanation.

Next, I am looking at long bonds at my broker:



2. One question I have here is why are the spreads so different for issues that are so close in maturity? For example the 2045 has a spread of 0.85% vs 1.7% for the 2048. I called them and was told it is 'supply and demand'. Mmmm... Is that right?

3. Another question is, are those spreads 'fair' and how do they compare to what you are paying? A spread of 1.7% is almost 1 year of interest... In his book, HB talks about 1.5% as an upper limit of what one could expect (and that was in 1987)

Any insights appreciated!

[Austen Heller]

US investor here, and I have only ever traded US treasury bonds, so my insight for you is meager.  Wow those are some large spreads!  Is the Canadian bond market very thinly traded?  In the US, the spreads are usually less than 0.1%, sometimes much less.  If you buy at auction, then there is no fee whatsoever, so then you would only have to pay part of the spread, if you sell before maturity.  Buy at auction, hold to maturity = no fees ever.  Does it work the same way up in Canada?

Hopefully someone with experience trading these Canadian bonds will weigh in here.

[gaston]

Thanks for the info Austen. Unfortunately we don't have the equivalent of treasury direct in canada, and we have to get bonds on the secondary market through brokers. Those price are from TD (second biggest bank).
Now if you buy a 30 year bond and keep it 10 years, a 1.7% spread is roughly 0.17% per year which is cheaper than most bond ETFs but still painful.
Investing in the US seems so mush cheaper maybe the solution is to move there...

[Austen Heller]

Thanks for the info Austen. Unfortunately we don't have the equivalent of treasury direct in canada, and we have to get bonds on the secondary market through brokers. Those price are from TD (second biggest bank).
Now if you buy a 30 year bond and keep it 10 years, a 1.7% spread is roughly 0.17% per year which is cheaper than most bond ETFs but still painful.
Investing in the US seems so mush cheaper maybe the solution is to move there...

Spreading it out over 10 years is a good way to think about it, lessens the pain.
As for moving to the US...

[gaston]

Alright so I asked the question to the author of this book: http://www.amazon.ca/In-Your-Best-Inter ... 1550028766

Here is what he said:

The 2045 maturity is what is known as an on-the-run issue which means that it is the most actively traded issue and is thus the benchmark for long term Canadas. Thus it trades at a tighter spread.

Yes, then, these are fair quotes. Re the TD's spread, I was referring to their commission and yes, they are fair. You can negotiate if you are doing
a large transaction, preferable $ 1 million but anything over $ 100,000 should give you some bargaining power.

So this explains why the 2045 is half the spread of the 2048, it's more liquid. I guess it also explains why the yield curve is not monotonic.

As explained here http://www.financialwisdomforum.org/for ... ad#p568062 the spread gets smaller as your purchase/sale size increases. You can see this by entering orders and seeing the price difference.

For example, for the 2048 bond:

order size - spread
>5k - 1.71%
>12k - 1.44%
>24k - 1.31%
>36k - 1.24%
>100k - 1.14%

So the 2045 seems to be the one to go for at 0.85% for a 5000$ minimum. If kept 9 years until it becomes a 20 year bond, it is roughly an expense of less than 0.1% per year, which is half the cost of a bond ETF like ZFL.

[whatchamacallit]

This 2012 article found qtrade to be the cheapest for government bond commisions:

http://www.theglobeandmail.com/globe-in ... cle546610/

The first bond was a Government of Canada issue, 4 per cent coupon, maturity date June 1, 2017. Quotes for a bond with $5,000 face value, the minimum usually required to make a trade, were obtained from the four firms within minutes of each other. The total cost ranged from $5,696.99 to $5,732.19. Qtrade listed the exact price shown in the Bondview inventory. This firm quoted the lowest total cost (bond plus commission), whereas BMO InvestorLine was the most expensive. The cost to buy $25,000 face value of the same bond returned similar results: Qtrade was the cheapest at $28,420.20 and BMO InvestorLine the most expensive at $28,660.95.