Investor 007's Bond Dossier

Meet Investor 007. His specialty? Bonds. Fixed-income bonds.

Don't be fooled by their low-profile reputation. Beneath that cunning disguise, bonds are sophisticated tools to help safeguard your portfolio from the perils of riskier investments. Here's the latest intelligence on their high-stakes world. If you're new to the game, get briefed on the basics of Investor 007's business, or check out our Bond Center for some useful gadgets to help ensure a successful investing mission.

Spying on rates
The benchmark U.S. Treasuries are key rates to keep under surveillance. Corporate issues are generally priced at a spread to a Treasury rate with a similar term, based on the issuer's credit rating.

Clues to the market
The broad credit market is influenced by a host of macroeconomic factors. Treasury prices remained stagnant for most of last week in quiet trading, declining slightly on Friday. Bond prices move inversely to yields.

With little in the way of economic news, Treasuries remained unchanged on Monday. Prices fell initially on Tuesday, following reports showing a rebound in November housing starts and the largest hike in producer prices since 1974. Once the data revealed that auto prices were mainly to blame, Treasuries rebounded to close mainly unchanged. Once again, without much in the way of significant economic news, Wednesday's bond action saw little movement. For the third consecutive day, the 10-year note traded close to a 4.6% yield.

Prices rose on Thursday in light trading, mainly due to a report that London was bracing for possible terror attacks over the holidays. The yield on the 10-year dropped to 4.55% and the 30-year yield slipped to 4.69%. During Friday's shortened holiday trading session, Treasuries fell in the face of rising consumer confidence and personal spending, but tame inflationary data. The 10-year note yield rose to 4.62%, its highest rate in a month.

Detecting developments

Investor 007 noted the following occurrences in the bond market last week:

• Moody's cut the long-term debt rating of Pfizer (NYSE:PFE) from AAA to Aa1 due to the recent failure of a promising drug in the company's pipeline.
• Standard & Poor's, a division of McGraw-Hill, cut the long-term debt rating of Anheuser-Busch (NYSE:BUD) from A+ to A due to the company's more aggressive leverage target.

Hot tip
Hybrid autos have appeal. Although they get a lot of mileage, however, some folks are holding off on purchasing them until long range safety data becomes more available.

A hybrid of a different sort is making inroads in the securities market. Bloomberg reported last week that data compiled by Lehman Brothers (NYSE:LEH) shows accelerating growth of hybrid bonds, up more than 55% from last year. In the past four months alone, approximately $26 billion worth of hybrid bonds were sold, about 40% of this year's total of $65 billion.

A hybrid bond carries both debt and equity characteristics. Hybrids appeal to issuers because ratings agencies typically don't count all of the money borrowed as debt, and interest can be paid with pre-tax profits. Interest payments can be deferred without triggering a default, and maturities may be perpetual, similar to preferred stock. Investors like hybrids for their higher yields and their ranking just behind senior secured debt in terms of bankruptcy repayments.

The article noted that investors are scooping up hybrids of MetLife (NYSE:MET) and Washington Mutual (NYSE:WM), with yields about 1% higher than other senior unsecured securities. The companies themselves are unlikely LBO targets, which are seen as ratings killers. Due to their regulatory oversight and higher credit needs, financial institutions rarely make appealing targets.

JPMorgan Chase (NYSE:JPM) recently created an index to track hybrid performance, and issuance is forecast to continue increasing. It pays to investigate these new securities as they come to market. Unlike the hybrid auto, safety does not seem to pose a great concern, and they could rev up your fixed income returns.

Moody's is a Stock Advisor pick; Pfizer and Anheuser-Busch are Inside Value selections; and JPMorgan Chase and Washington Mutual are Income Investor picks. Try any of our Foolish newsletters free for 30 days.

Fool contributor S.J. Caplan has been an undercover fixed-income aficionado ever since serving in banking and legal capacities covering debt underwriting as well as fixed income derivatives. She owns U.S. Treasuries and shares of the Fidelity Inflation Protected Bond Fund, but holds stock in no other companies mentioned. She prefers her portfolio shaken, not stirred. The Fool has a disclosure policy.