WHAT ARE BONDS?

     A bond is a debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it "matures," or comes due.

     Among the types of bonds you can choose from are: U.S. government securities, municipal bonds, corporate bonds, mortgage and asset-backed securities, federal agency securities and foreign government bonds.

WHY INVEST IN BONDS?

     Most personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds, stocks and cash in varying percentages, depending upon individual circumstances and objectives. Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and to increase their capital or to receive dependable interest income. Whatever the purpose-saving for your children's college education or a new home, increasing retirement income or any of a number of other worthy financial goals-investing in bonds can help achieve your objectives.
     That's especially true for retirement planning. During the past decade, the traditional fixed-benefit retirement plans have increasingly been replaced by defined contribution programs, such as 401(k) plans. While these plans offer greater individual freedom in selecting from a range of investment options, investors must also be increasingly self-reliant in securing their retirement lifestyles.
     The diversity of fixed-income securities present investors with a wide variety of choices to tailor investments to their individual financial objectives. Whatever your goals, your investment representative can help explain the numerous investment options available to help you reach them, taking into account your income needs and tolerance for risk.

KEY BOND INVESTMENT CONSIDERATIONS

     There are a number of key variables to look at when investing in bonds: the bond's maturity, redemption features, credit quality, interest rate, price, yield and tax status. Together, these factors help determine the value of your bond investment and the degree to which it matches your financial objectives.

Maturity
     A bond's maturity refers to the specific future date on which the investor's principal will be repaid. Bond maturities generally range from one day up to 30 years. In some cases, bonds have been issued for terms of up to 100 years. Maturity ranges are often categorized as follows:

1. Short-term notes: maturities of up to 4 years;
   
2. Medium-term notes/bonds: maturities of five to 12 years;
   
3. Long-term bonds: maturities of 12 or more years.

Redemption Features
     While the maturity period is a good guide as to how long the bond will be outstanding, certain bonds have structures that can substantially change the expected life of the investment.
     Call Provisions For example, some bonds have redemption, or "call," provisions that allow or require the issuer to repay the investors' principal at a specified date before maturity. Bonds are commonly "called" when prevailing interest rates have dropped significantly since the time the bonds were issued. Before you buy a bond, always ask if there is a call provision and, if there is, be sure to obtain the "yield to call" as well as the "yield to maturity." Bonds with a redemption provision usually have a higher return to compensate for the risk that the bonds might be called early.

Puts
     Conversely, some bonds have "puts," which allow the investor the option of requiring the issuer to repurchase the bonds [at a specified time] prior to maturity. Investors typically exercise this option when they need cash for some purpose or when interest rates have risen since the bonds were issued. They can then reinvest the proceeds at a higher interest rate.

Average Life
     In addition, mortgage-backed securities are typically priced and traded on the basis of their "average life" rather than their stated maturity. When mortgage rates decline, homeowners often prepay mortgages. This may reduce the average life of the investment. If mortgage rates rise, the reverse may be true-homeowners will be slow to prepay and investors may find their principal committed longer than expected.
     Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment return you are seeking within your risk tolerance. Some individuals might choose short-term bonds for their comparative stability and safety, although their investment returns will typically be lower than would be the case with long-term securities. Alternatively, investors seeking greater overall returns might be more interested in long-term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks.

Credit Quality


     Bond choices range from the highest credit quality U.S. Treasury securities, which are backed by the full faith and credit of the U.S. government, to bonds that are below investment grade and considered speculative. Since a bond may not be redeemed, or reach maturity for years-even decades-credit quality is another important consideration when you're considering a fixed-income investment. When a bond is issued, the issuer is responsible for providing details as to its financial soundness and creditworthiness. This information is contained in a document known as an offering document, prospectus or official statement, which will be provided to you by your investment representative. But how can you know whether the company or government entity whose bond you're buying will be able to make its regularly scheduled interest payments in five, 10, 20 or 30 years from the day you invest? Rating agencies assign ratings to many bonds when they are issued and monitor developments during the bond's lifetime. Securities firms and banks also maintain research staffs that monitor the ability and willingness of the various companies, governments and other issuers to make their interest and principal payments when due. Your investment representative can supply you with current research on the issuer and on the characteristics of the specific bond you are considering.

Credit Ratings
     In the United States, rating agencies include Moody's Investors Service, Standard & Poor's Corporation, Fitch IBCA Inc. and Duff & Phelps Credit Rating Co.. Each of the agencies assigns its ratings based on an in-depth analysis of the issuer's financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond. The highest ratings are AAA (S&P, Fitch IBCA, DCR) and Aaa (Moody's). Bonds rated in the BBB category or higher are considered investment-grade; securities with ratings in the BB category and below are considered "high yield" or below investment-grade. While experience has shown that a diversified portfolio of high-yield bonds will, over the long run, have only a modest risk of default, it is extremely important to understand that, for any single bond, the high interest rate that generally accompanies a lower rating is a signal or warning of higher risk.

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