What happens when a bond you bought for less than its face value gets called?

[Pointedstick]

So let's say I decide to buy a Puerto Rico bond at a big discount. Say, $700 for a $1,000 face value bond. Let's say at some point it gets called. What happens? Do I get the $1,000 face value back, even though I bought it for less than that?

[Ad Orientem]

So let's say I decide to buy a Puerto Rico bond at a big discount. Say, $700 for a $1,000 face value bond. Let's say at some point it gets called. What happens? Do I get the $1,000 face value back, even though I bought it for less than that?

Yes. They have to pay back the bond's face value.

[Pointedstick]

Would that count as a capital gain?

[Ad Orientem]

Would that count as a capital gain?

I believe it would. But as always, where legal matters are concerned check with your accountant or tax adviser to be sure.

[dualstow]

This article says that in some cases you would get your money back + a premium.
http://www.investopedia.com/articles/bo ... alling.asp

It's compensation for having to reinvest your capital elsewhere if you want income.

[Pointedstick]

Looks like you're right that it's taxable.

Still, I have to say I reeeeeally want to buy some Puerto Rican bonds. I mean, since they'd be bought at such a steep discount, even if they're called, you kind of win there anyway since you get back more then you paid, even if it's a taxable gain.

Of course you'd be screwed if they defaulted. But that's the risk, I suppose.

[MediumTex]

Does Puerto Rico have a history of defaulting on its debt?

[dualstow]

Are you serious, PS?
I hope you're just going to nibble. After AO's thread I read up on them, and having the bonds called is not what I'd be worried about.
I suppose a nibble could be fun, though.

[Pointedstick]

Are you serious, PS?
I hope you're just going to nibble. After AO's thread I read up on them, and having the bonds called is not what I'd be worried about.
I suppose a nibble could be fun, though.

Semi-serious. Not a lot of money, just a bit. The way I see it, there are three options:
1. I get a nice fat tax-free interest payment for a long time. Win.
2. The bonds get called and I wind up with more money than I started. Win.
3. Interest payments stop because the debt has been defaulted on or "restructured". Lose.

The likelihood of #3 happening is of course the key. Their constitution is pretty clear that bondholders have to be paid no matter what, so that's something. But if the money just ain't there, well…

[Ad Orientem]

PR bonds should probably be on the high end of the junk rating (BB) as opposed to low end of investment grade. Even so the default rate for non-investment grade municipal bonds is really low. And while PR is a fiscal mess, they are not (yet) a fiscal disaster. Which is to say they are not Detroit. But I would be careful about putting too much weight in the constitutional guarantees to bond holders. Remember Michigan's constitution guarantees pensions. But the Federal Courts just ruled that US Bankruptcy Law trumps those provisions.

Of course PR is like a state in that there is no legal mechanism for bankruptcy (yet).

All in all I think PR bonds may be trading a bit cheap right now. I'd call this a decent speculative bet. But it is speculative.

[dualstow]

It just seems too good to be true, doesn't it?
Out of curiosity, I went to the bonds section of Vanguard and typed in Puerto Rico as the issuer.

At the top of the list is CUSIP: 745220EF6, "Puerto Rico Comwlth Infrastruc Special Tax Revenue Bond Series."
Yield to Worst 8.850; Yield to Maturity 8.850
Maturity 07/01/2025
Moody's Rating Baa3; S&P BBB+
Callable No
Defeased No (No idea what that is)

Tax status
Subject to federal tax No
Subject to state tax No
Subject to AMT No
Bank qualified No

Hmm. I think I need to turn off the pleasant sounds of Allman Brothers 'High Falls' playing on the radio and put on something with tritones by Black Sabbath until I understand more.

EDIT: meant to also write:
Insured Yes
Insurer FGIC

[MediumTex]

It just seems too good to be true, doesn't it?
Out of curiosity, I went to the bonds section of Vanguard and typed in Puerto Rico as the issuer.

At the top of the list is CUSIP: 745220EF6, "Puerto Rico Comwlth Infrastruc Special Tax Revenue Bond Series."
Yield to Worst 8.850; Yield to Maturity 8.850
Maturity 07/01/2025
Moody's Rating Baa3; S&P BBB+
Callable No
Defeased No (No idea what that is)

Tax status
Subject to federal tax No
Subject to state tax No
Subject to AMT No
Bank qualified No

Hmm. I think I need to turn off the pleasant sounds of Allman Brothers 'High Falls' playing on the radio and put on something with tritones by Black Sabbath until I understand more.

EDIT: meant to also write:
Insured Yes
Insurer FGIC

I need more information about all of that.

I don't understand.

[dualstow]

I think the bottom line is that it is a tax-free junk bond and that the risk is what PS wrote in his 3rd point. But there's a fourth, even if it doesn't have a number 4 in front of it.

Their constitution is pretty clear that bondholders have to be paid no matter what, so that's something. But if the money just ain't there, well…

High risk, high yield. "Money you can afford to lose" territory.
Could very well have a happy ending, though.

[Ad Orientem]

Puerto Rico muni bonds: A contrarian view...

http://www.investmentnews.com/article/2 ... /309299983

[Libertarian666]

"Defeased" means that the issuer has pre-refunded repayment, usually by buying Treasurys in the same amount, so they are no longer on the hook for them themselves.

Needless to say, junk bonds are rarely defeased.

[dualstow]

Ha, thank you. That was a year ago so I've had time to look it up.