Your Choices

FOR small and substantial investors alike, bonds now appear to offer an unusual opportunity. In mid 1989, corporate AA rated industrial bonds were paying interest that was nearly five percentage points higher than the rate of inflation. And that was two to three times as much real interest as bonds historically pay.

You will probably do best buying U.S. Treasury issues or perhaps AAA rated corporate bonds. Yields on 30 year Treasuries in mid1989 were about 8.7%. That compared with the 9.67% available on top rated corporate. This was a spread that made T bonds the wiser choice of the two. Corporate bonds yield more to reward you for taking a chance that the company that issues the bond might get into trouble and be unable to pay the interest or principal when it comes due. Not only are Treasuries safer the U.S. government would have to fall before they default but also the interest they pay is exempt from state and local taxes. Sorry, you do have to pay federal taxes on it.

There is another important difference: when interest rates drop, private companies often "call" that is, buy back their high yielding bonds. By contrast, 30 year Treasury bonds are "noncallable" for at least 25 years, and some are protected for the full 30 years; all other Treasury bonds are totally "noncallable." So you can hold on to these high yielding bonds for a long time usually until they mature with no fear that the government will force you to sell out. When you buy any kind of corporate or municipal bond, you should check to see how soon it can be called in by the issuer. Some corporate bonds guarantee against calls for up to 10 years.

Municipal bonds are hard to buy in units smaller than $5,000. They are equally tough to sell without paying a high commission if you own fewer than 25 bonds. So the best way for most people to buy these securities is through one of the tax free bond municipal funds. (See "Your Investments/Bonds: Tax exempt Municipals.")

Investors who yearn for that old fashioned bond market religion that is, for a faithful return without much risk should shop for a bond that is way down in price. These deep discount bonds were issued 25 years ago, when interest rates were only 4%. Naturally, nobody would buy a bond today that pays only 4%. So the prices of these bonds have tumbled deeply in the market. Consequently, you can go to a stockbroker and for much less than $ 1,000 buy a bond that will pay you back $ 1,000 when it matures some years from now and in the meantime pay you its regular, though modest, interest.

Many analysts say that among the best deep discount bonds are those that were issued by the old telephone company. For example, in mid 1989, you could buy $1,000 worth of AT&T's 43/ 1% bonds maturing in 1992 for only $880. The interest that these bonds pay is small, which is why they are cheap. But you can use a discount bond to build a college fund for the children. Deep discount bonds should not be confused with low quality bonds those rated BB+ or lower, which are rather affectionately known as junk bonds. They reflect weak spots in the issuer's financial armor and behave more like stocks than bonds. Their prices tend to rise in line with improvements in the economy or in the fortunes of the issuing company.

Speculators who aim for maximum capital gains but are willing to take maximum risk, too might consider convertible bonds. They are called "convertible" because they can be swapped for a stated number of shares of the issuer's stock. A convertible's price swings not only with interest rates, but also with the issuing company's underlying shares. When share prices rise or fall, so do convertible prices.