Municipal Bond Forum
On “GM Turnaround Hits High Gear”
Q
I own bonds at FMS that mature in 2030, but I am not a bond expert. Although I consider myself a somewhat risk-tolerant investor, wouldn’t it be a more prudent strategy, if one is looking at total yield (income plus growth) to purchase a company’s stock rather than downgraded bonds that yield 8% to 10%? I am thinking of both the upside and downside potentials here. On a stock, one can also put a stop-loss order at a certain level and limit the downside potential, while the upside potential is infinite. With bonds, if the company defaults on payment, you’re SOL, and the upside potential is limited to the bonds’ yield, unless the prevailing interest rate diminishes.
A
James A. Klotz responds:
We believe an investor who has confidence in a GM turnaround has better profit potential with GM’s bonds as opposed to its common stock.
It is inaccurate to say that the return on the bonds is limited to the yield at the time of purchase. Your South Carolina 6 3/8% tobacco bonds purchased in September 2004 provide a perfect example. You paid 91.474 for these non-callable bonds that, at the time, represented a 7.10% yield to maturity.
These bonds can be sold today for approximately 109.125, producing a profit of $17.65 per bond or 9.64% annually for the two years you have held these securities. Add in the 6.375% tax-free income you have collected and you have an annual total return of over 16%, well in excess of the original yield promised.
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