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By HELEN HUNTLEY
© St. Petersburg Times, published October 22, 2000
Q. Three days before the end of the month, I bought short-term bank CDs and municipal bonds. The confirmation slips say that the brokerage company acted as principal and that a $5 transaction fee was charged on each bond. I was surprised when the end-of-the month statement showed unrealized losses of 2 percent of the amount invested for the bond and about one-third of 1 percent for the CD. There was no drastic change upward in interest rates during the three-day period between purchase and reporting, so I can only surmise that the loss in market value represents the brokerage's charges. What's going on here?
A. Commissions are not the only way brokerage companies make money on trades. And I'm not talking about the $5.
The "principal" reference means that the company was selling you securities from its own holdings. It makes a profit on the difference between the price it pays for securities and the price at which it sells them to you and other investors. This difference is the markup.
A brokerage company is required to disclose the markup for stocks on confirmation statements, but not for fixed-income investments. If you want to know, ask the broker how much the company is paying to buy that same bond from investors. This is the "bid" price.
"You should discuss this with an adviser," said Greg Ghodsi, a broker with Robert W. Baird & Co. in Tampa. "You want the person you're dealing with to make money so they can stay in business and keep taking care of you, but you should know what you're stepping into."
Markups vary with the type of bond, the maturity and the credit quality. Markups tend to be smaller on short-term, high-quality government and municipal bonds and larger on high-yield "junk bonds." The differences partly reflect variations in the risk the brokerage company takes when it buys bonds for its inventory. They also reflect competition or lack of it.
Ghodsi said a 2 percent markup would be about the most he would expect on a high-quality, long-term Florida municipal bond.
The best way to know whether you are being offered a good deal on a fixed-income investment is to compare its yield with the yields other brokerage companies offer on bonds of the same quality, maturity and call features. The same is true for CDs.
Be glad that your statements show these unrealized losses. Over the years brokerage companies have created a lot of grief for themselves and their customers by listing investments such as limited partnerships at original cost rather than at market value.
Q. I have more than $100,000 in E and EE savings bonds held in a trust with my daughter as the successor trustee. The property is to be distributed equally among my five children. Will she have to cash all the bonds at my death? What will determine the tax bracket on the interest?
A. Unless the trust language says otherwise, your daughter can choose whether to cash the bonds at your death. When a savings bond owner dies, there are three basic options for reporting and paying tax on the accrued interest income. The first is to include the interest on the bond owner's final tax return. The second is to include it in the estate. The third is to pass the tax obligation to the beneficiaries along with the bonds. When the time comes, it is a good idea to calculate the taxes all three ways to decide which one is best.
You also might consider cashing the bonds gradually before your death, particularly if you are in a lower tax bracket than your children.
If you own stock options, check out MyCriticalCapital.com (http://www.mycriticalcapital.com). The Web site is designed to help investors balance risk against tax savings and profits when making decisions about exercising options.
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