Portfolio Evaluation Service (PES) and Fixed Income Products

Interpreting cost for fixed income securities can be a challenge due to the intricacies of fixed income instruments. Based on certain conditions, cost basis may need to be adjusted upward or downward and may be considered return of principal, interest income, or capital gain or loss. Additionally, in some cases an investor can choose as to whether to report these adjustments during the life of the bond or upon redemption.

Outlined in this article is a general explanation of fixed income products and how they are displayed on Pershing’s Portfolio Evaluation Service (PES) and the client monthly brokerage account statement.

The following will explain how PES calculates and displays adjusted cost. For the purpose of this discussion, fixed income instruments will fall into one of the following categories:

  • Zero coupon bonds
  • Discounted bonds
  • Asset-backed securities
  • Market premium bonds
  • Market discounted bonds

It is important to note here that within these categories, PES currently does not differentiate between taxable and non-taxable bonds.

Zero coupon bonds pay no interest and are purchased at a deep discount to the par value, which is paid at maturity. The difference between the purchase price and maturity value is reportable as interest income over the life of the bond (unless it is held in a tax deferred account). This accretion of interest causes the cost of the bond to increase over its lifetime. To accommodate this, PES proportionately increases the cost of the bond each month using the scientific yield calculation. This process also keeps the cost of the bond in line with market value, which also increases as the bond approaches maturity.

Discounted bonds are similar to zero coupon bonds in that they are purchased at a discount to par value and pay no interest. The difference between purchase price and par value is also reportable as interest income. As with zero coupon bonds, PES increases the cost basis each month by the amount of the accretion apportioned to the month. Accretion on discounted bonds, however, is calculated using the straight-line calculation.

If either a zero coupon or discounted bond is sold prior to maturity, and the client will incur a capital gain or loss.

 Asset-backed securities are generally issued at their par value, which is reduced as principal is paid back on the loans underlying the security. The par value remaining on the security is represented by the security’s “factor.” For instance, on a $100,000 Asset-Backed Securities that has paid back $25,000 in principal, the factor would be .75, meaning that 75 percent of the original par value remains. The factor also represents the reduction in cost basis calculated in PES. In the above example, if the bond was purchased at 100, the new cost basis would be $75,000 ($100,000 x .75).

Market premium and discounted bonds are coupon bearing bonds purchased either above or below their par value. The premium paid may be reportable as a capital loss and any discount may be reportable as a capital gain. On a regular corporate or government bond, the investor has a choice as to whether to take the gain or loss along the life of the bond, or upon redemption. On municipal bonds, the investor must not take a loss if the bond was purchased at a premium. For municipal bonds purchased at a discount, however, the gain is reportable. The investor’s option, however, is to either report the gain along the life of the bond, or upon redemption.*

* For municipal bonds purchased at a discount or premium, the gain or loss is reportable along the life of the bond, and proportionate to the amount of principal being returned to the investor

Trademarks of Pershing Investments LLC.

The information contained in these materials is believed accurate at the time of writing but is not guaranteed. Delta accepts no responsibility for its use whether in whole or in part.