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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.

U.S. Treasury















Clues to the market
The broad credit market is influenced by a host of macroeconomic factors. Last week, Treasury prices broke their losing streak and gained as investors worried about the impact of subprime troubles. For the week, the two-year note yield dropped 13 basis points to 4.90%, while the benchmark 10-year yield declined 3 basis points to 5.13%, and the 30-year yield slipped 1 basis point to 5.25%. Bond prices move inversely to yields.

The week began with a weak housing index report giving a lift to Treasury prices on Monday. The 10-year yield dropped 2 basis points to 5.15%. Prices continued to climb on Tuesday, helped by data indicating soft housing starts, and the 10-year yield dropped to 5.07%.

The bond market's four-day winning streak ended on Wednesday. Concerns regarding corporate hedging ahead of issuance and a decline in German government bonds pressured prices and led to a rise in the 10-year yield to 5.14%.

Prices were mixed on Thursday as the yield curve steepened. Amid concerns about losses at hedge funds managed by Bear Stearns (NYSE: BSC  ) , the two-year yield remained nearly flat while the 10-year yield rose 4 basis points to 5.18% thanks to a report announcing strong mid-Atlantic business conditions. A flight to the safe haven of Treasuries from falling stock prices produced gains on Friday. The week ended with the two-year yield dropping 7 basis points to 4.90% and the 10-year yield falling 5 basis points to 5.13%.

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

  • The Federal Reserve is expected to leave its target interest rate unchanged at 5.25% as it meets this week to discuss policy and announce its decision Thursday afternoon.

  • Bear Stearns announced on Friday that it will bail out its High Grade Structured Credit Fund with $3.2 billion in loans and will remain working on solutions for its High Grade Structured Credit Enhanced Leveraged Fund.

  • Italian dairy company Parmalat announced that a U.S. bankruptcy judge awarded it a permanent injunction to protect it against claims from Bank of America (NYSE: BAC  ) and other creditors.

  • Corporations issuing debt included the following:

    • Georgia Power, a unit of Southern Company (NYSE: SO  ) , sold $150 million in five-year extendible notes.
    • HRPT Properties Trust (NYSE: HRP  ) sold $250 million in 10-year notes.
    • Idaho Power, a unit of Idacorp (NYSE: IDA  ) , sold $140 million in 30-year first mortgage bonds.
    • JPMorgan Chase (NYSE: JPM  ) sold $750 million in 10-year subordinated notes.
    • Marriott International (NYSE: MAR  ) sold $350 million in 10-year senior notes.
    • Northern States Power, a unit of Xcel Energy (NYSE: XEL  ) , sold $350 million in 30-year first-mortgage bonds.

Hot tip
Who pays the price when shareholder activists fight for corporate changes?

According to a recent report by Moody's (NYSE: MCO  ) , and as reported by Bloomberg, it's you, the bondholder. The type of activist discussed in the report is not the Greenpeace corporate responsibility kind, but rather the Carl Icahn variety -- a shareholder who typically has a short-term investment horizon of two years or less in a company's equity and uses proxy threats or the media to argue for changes such as acquisitions, asset sales, and share buybacks.

The effect of such actions typically drives the price of the company's shares up but damages its credit rating. The report specified Time Warner (NYSE: TWX  ) as an example. Icahn has pressured Time Warner on several matters, including an increase in its buyback program. Once the company announced in March 2006 that it was raising its share-buyback program to $20 billion from the originally planned $5 billion, Moody's lowered its ratings on the company from Baa1 to Baa2.

Meanwhile, just last week, Home Depot (NYSE: HD  ) announced plans to buy back as much as $35 billion in shares and borrow approximately $12 billion to fund the purchase. Moody's and Standard & Poor's, a division of McGraw-Hill (NYSE: MHP  ) , each wasted no time in stating that the company was under review for a possible downgrade.

While the short-term investor benefits from the stock spike and the sells, the bondholder is left owning securities of a lesser-quality company whose prices have likely declined. Short-term shareholder activism is on the rise, so while you investigate your prospective issuer's entire financial picture, keep your eye out for any of Icahn's types lurking in the picture before you purchase its debt.

Bank of America and JPMorgan Chase are Motley Fool Income Investor recommendations. Take a free 30-day trial to discover more high-yielding investments.

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. Home Depot is an Inside Value recommendation, and Moody's is a Stock Advisor pick. The Motley Fool's disclosure policy prefers its portfolio shaken, not stirred.

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