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. Last week, Treasury prices gained for the second consecutive week, as the Fed unsurprisingly kept rates unchanged. For the week, the two-year note yield slipped 3 basis points to 4.87%, while the 10-year yield declined 10 basis points to 5.03%, and the 30-year yield dropped 13 basis points to 5.12%. Still, the second quarter ended with the worst quarterly performance of Treasuries in more than a year, with the benchmark 10-year yield climbing 38 basis points. Bond prices move inversely to yields.

The flight to quality begun the prior week over subprime concerns continued on Monday. A weak home sales report also spurred purchasing, and Treasuries rallied. The two-year yield declined to 4.87%, its lowest rate this month, and the 10-year yield fell 5 basis points to 5.08%. Prices slipped on Tuesday, following a report of a decline in new home inventories. The two-year yield tacked on 1 basis point, while the 10-year yield increased by two basis points. On Wednesday, a surprisingly weak durable goods report sent prices initially higher, before they dropped back to close little changed.

Treasuries languished Thursday morning, ahead of the FOMC afternoon announcement on interest rates. Prices fell once news broke that the benchmark lending rate will remain at 5.25%, with inflation cited as the greatest risk to the economy. The two-year yield rose 5 basis points to 4.94%, while the 10-year yield rose 3 basis points to 5.11%.

Prices rallied on Friday. Various factors contributed to the buying, including a terrorist scare in the U.K., tame consumer price inflation data, and month-end purchasing. The two-year note yield staged its largest drop in since March, and declined 7 basis points.

The market will close at 2:00 tomorrow and remain closed on Wednesday to celebrate July 4.

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

• The U.S. Treasury sold $18 billion in two-year notes on Tuesday at a yield of 4.906%, and sold $13 billion in five-year notes on Wednesday at a yield of 4.94%.
  
  
• A group of Tyco (NYSE:TYC) bondholders joined a lawsuit trying to stop the company's planned spinoff of its electronic and health-care businesses, because of the company's alleged failure to obtain bondholder consent.
  
  
• The SEC has opened 12 enforcement investigations into matters involving collateralized debt obligations (CDOs).
  
  
• JPMorgan Chase (NYSE:JPM) said that the amount of high-grade CDOs backed primarily by subprime mortgages has dropped to $3 billion, from $20 billion a month ago.
  
  
• Moody's (NYSE:MCO) said that it expects to downgrade more CDOs this year than it did last year.
  
  
• Thomson Financial reported that U.S. high-yield bond issuance rose in the first half of the year to $93.7 billion, compared to $65.4 billion a year ago.
  
  
• Underwriters indefinitely postponed a $1.55 billion bond offering by U.S. Foodservice.
  
  
• U.S. bank regulators issued tighter standards for mortgage lending to curtail risky practices.
  
  
• The following corporations issued debt in the public market:
• Equifax (NYSE:EFX) sold $300 million in 10-year notes.
• Suncor Energy (NYSE:SU) sold $750 million in 31-year bonds.

Hot tip
If you want to know how the pros check on the pulse of the subprime mortgage market, you need to know about the ABX indexes.

Although these indexes were begun quietly just last year by Markit Group, a U.K. company, they're now attracting Wall Street's attention as focus intensifies on the subprime sector. The indexes collect data from dealers and banks that trade credit derivatives -- contracts used to transfer credit risk and protect against an issuer's default. These transactions don't take place on a public exchange, so the information provided by the indexes allows greater transparency into underlying price data.

The ABX indexes specifically track credit derivatives tied to U.S. mortgage loans with a riskier credit profile. The data is sold to clients, typically banks and hedge funds. The Wall Street Journal recently cited Lehman Brothers (NYSE:LEH) and Deutsche Bank (NYSE:DB) as using the index to hedge against losses.

Just last week, Reuters reported that the ABX indexes fell to fresh lows. You may not like what you hear about the subprime market, but at least now you'll know about one source widely used for making those pronouncements.

Tyco is an Inside Value recommendation. JPMorgan Chase is an Income Investor selection. Moody's is a Stock Advisor pick. Try any of our Foolish newsletters free for 30 days.

Fool contributor S.J. Caplan has been an undercover fixed-income aficionado ever since she served 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. She prefers her portfolio shaken, not stirred. The Fool has a disclosure policy.