The bond still paid a fixed interest rate (coupon) based on the original $1,000. While new buyers were getting 5%, Arthur’s effective yield-to-maturity was nearly double because he had paid so much less for the same interest check.
The town gossips at the diner laughed. "Arthur’s buying debt in a sinking ship," they chuckled. But Arthur had read the fine print. He knew the utility’s assets were solid and that the "sinking ship" was just undergoing a very expensive repair. buying bonds at a discount
Fast forward five years. The utility company hadn't just survived; it was thriving. As the "fear" evaporated, the bond's price climbed back toward its $1,000 face value. The bond still paid a fixed interest rate
By buying at $650, Arthur had unlocked a double-sided gold mine: "Arthur’s buying debt in a sinking ship," they chuckled
Bonds have a legal obligation to pay back the full $1,000 at the end of their term. Arthur was essentially buying a future $1,000 for a $350 discount.
Arthur wasn’t a gambler, but he loved a good fire sale. While everyone else was chasing the booming tech stocks of the early 90s, Arthur was digging through the wreckage of a massive regional utility company that had suffered a catastrophic (but ultimately fixable) technical failure. Its corporate bonds, originally issued at a of $1,000, had plummeted to $650 .
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