This tip will be a little technical, but an important aspect of the bond market is becoming an issue. Here is a prime example. Right now there is a Toyota Motor bond that yields 3.1% for 18 months. It’s an AA credit, one of the highest available in the investment world. And it’s non-callable. Sorta.
The provisions in this bond say it’s Non-callable, Make Whole Calls. What the heck does that mean? It means that they can call the bond in as long as they pay you all the interest you’d be owed if you waited until next year. But there is a serious gotcha. If they do call the bond, they don’t pay you 3.1%. Instead they pay you the US Treasury rate plus 0.1%. Back in the olden days (say a month ago) when Treasuries were 1.5%, that’s not a big risk. But today, with Treasuries yielding 0.25%, it’s not a great deal. If Toyota were to call the bond today, they’d give you your money back, but only pay you 0.35%. That’s gotcha number one. Gotcha number two is that right now this bond trades at a premium. So you’d lose the premium and just get back 0.35%. Essentially you get no profit if they exercise the make whole calls provision.
Finding out what the rules are for the make whole calls is a hassle. You have to find the prospectus on the SEC website and read the fine print.
The lesson here is, if you’re looking at two similar bonds and one has a make whole calls provision and one doesn’t, skip the one with the hidden gotcha.