High interest rates in the 12-to-15- percent range for long-term, high-quality bonds have created havoc among conventional investors. But this crisis may open a double benefit for canny money nanagers.
As long as inflation was moderate (1 to 2 percent annualy), bonds provided secure earnings for insurance companies, pension funds, and private investors. But the high interest rates of today undercut the value of bonds issued years ago. Here's why:
Bonds issued several years ago by major corporations, such as American Telephone & Telegraph, carried low rates. A typical rate may have been 5 percent. This coupon rate of 5 percent meant that a $1,000 bond paid $50 interest each year. If current bond rates are 10 percent, no investor will buy one paying only $50 a year at its face value of $1,000. To pay a current 10 percent interest, The 5-percent bond is worth only $500, because the $50 coupon yield is equivalent to 10 percent of $500, although on maturity the bond would still bring the face value of $1,000.
Deep-discount bonds, mentioned frequently in "Moneywise," are long-term bonds (usually 20 or more years to maturity) that carry a low coupon rate and a high credit rating (AAA is the highest rating). One example is an AT&T bond with a coupon rate of 5 1/8 due April 1, 2001. Recently those bonds were selling for 47 1/2 ($475 for each $1,000 bond).
If interest rates go down, the value of the 5 1/8-percent interest increases, and the bond price rises.
For example, interest rates could decline to the point where the 5 1/8 bonds that a buyer paid $475 for now go up to $600.
When considering bonds for investment, remember these specifics:
* Buy when interest rates are high (bond prices low). Be prepared to sell when interest rates decline (bond prices rise). Buying bonds for a long-term holding is not advisable as long as inflation continues to go higher.
* Selling at the right time is just as important as buying at the rigth time. You buy and sell previously issued bonds on the secondary market through a stockbroker.
* When selecting specific issues, pick high quality (AAA, AA -- possibly A) with a long maturity -- at least 20 years. Over this span the value of waiting for full price at maturity is negligible.
* Select issues with a low coupon rate. In the example, coupon rate is 5 1/8 percent ($51.25 interest per year). Buying recent bonds with higher coupons could cause the price to increase beyond the $1,000 face value and possibly lead to the bonds' being called in the issuing company.
* If possible, buy bonds is increments of five and no fewer than five to keep buy and sell costs to a minimum. Ordinarily, you can expect to pay less in commissions when buying bonds than when buying stocks for comparable dollar amounts.