How CABs work

By Joel Thurtell

Wanta parley three hundred bucks into five grand?

Easy. Here’s how you could’ve done it last summer, had you known that the Poway Unified School District in San Diego was going to issue Capital Appreciation Bonds at a 94 percent discount.

And if you’d bought one of the Poway bonds with a face value of $5,000.

Your cost?

$300.

Forty years later, you will collect five thousand smackers.

Sweet, huh?

Good ol’ compound interest.

Poway borrows $105 million in 2011.

The school pays no interest for a couple decades.

That’s why CABs sometimes are called “zero coupons.”

The “coupon rate” of a bond is the annual interest the borrower pays for use of the money. A normal, current interest bond might have a coupon rate of five percent, meaning the investor is paid five percent interest per year.

Current-interest bonds work something like a home mortgage. A borrower might expect to pay interest equal to the loan principal.

CABs don’t pay interest for a number of years. The coupons have zero interest.

But oh boy! Interest is compounding all the while.

And “zero” is not its middle name.

By 2051, if you bought a $5,000 Poway bond for $300, you will collect $4,700 in profit.

Collectively, investors will reap nearly $1 billion in interest on Poway’s $105 million debt.

Who pays?

Why, the taxpayers of Poway, that’s who.

Capital Appreciation Bonds, or “zero coupon” bonds, are such a massive rip-off that Michigan banned CABs in 1994.

Now you know how to turn $300 into five grand.

If you time things right and know the right people.

Do you pay taxes in Poway?

Too bad!

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