Well, what are we to make of this yield curve?
This yield curve was plotted from the data prepared for the ‘Operating Retractible’ Index on 2006-07-26. The x-axis is modified duration, the y-axis is the pre-tax yield to maturity. Both data elements are obtained from the “YTW Scenario” – i.e., assuming a maturity-date and associate redemption price that reflects the worst-case-scenario (given current conditions) for the shareholder.
Retractible prefs are the class of prefs that behave most like bonds (an assertion I’ll prove at some point in the future, probably in a published article … for now, just trust me!) so one would expect that a yield curve would be a relatively smooth looking thing.
No such luck! BAM.PR.J, with a yield of 4.54% until its presumed redemption in March 2018, well above the curve, while PWF.PR.D seems well below its peers, having a YTW of only 1.87% based on a call at $26.00 in November 2007.
Could it be that the market is pricing the latter issue based on a redemption at $25.00 immediately prior to the retraction date in October 2012? Its yield based on the 2012 call is currently 3.72%, which is much closer to what comparable issues are paying. It is, perhaps, due to this sort of behaviour that HIMIPref finds the concept of portfolio yield useful in preferred share valuation.
The graph shown isn’t definitive, of course. No allowance has been made for credit rating and it is certainly possible to argue that the yield premium available on BAM.PR.J is mere compensation for the risk that its Pfd-2(low) rating from DBRS implies relative to the other labelled data points, which are all Pfd-1(low) – or simply that its extremely long time until its retraction privilege becomes exercisable make the other data points irrelevant for pricing purposes. It is also entirely valid to argue that the market is pricing in higher yields for the future, which will make the earlier redemption of PWF.PR.D less likely.
Arguments, arguments … that’s what makes a market!
