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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35367  
Subject: Re: Risks w/ municipal bonds? Date: 5/19/2009 9:59 PM
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AM,

Good questions all.

What I am saying is that across most of the debt spectrum, CDs, MMA, MMF, bond funds, Treasuries and many Muni and Corporate bonds, debt is priced too high. Keep in mind interest rate, or return, is inversely related to price.

Low interest rates mean the sellers are getting more bang for their buck, that means as buyers we are getting less for ours. It is most easily seen in bonds which are actually priced above or below face value. It is in our best interests to buy cheap.

Lets say Widget Inc needs to raise 100k in capital and decides to sell some bonds, borrow some money. If they can sell at at par they will have to sell 100 bonds. If they have to sell at 50 they need to sell 200 bonds. If they can sell at 200 the only need to sell 50.

100 bonds at maturity = 100k
200 bonds at maturity = 200k
50 bonds at maturity = 50k

The example is extreme to get the point across. Higher "prices" is good for the seller/borrower, higher prices = lower interest rates. Lower prices are good for they buyer/loaner, lower prices = higher interest rates.

Currently interest rates are low across most of the debt spectrum. Good for borrowers, bad for loaners.

This leaves the fixed income seekers in a bind. The simplest answer is to stay relatively short on the maturity length. What this does is gives us a better chance at capturing better rates when the interest rates do rise. This also means that our near term returns are going to be poor. The good news is that longer term vehicles aren't dramatically outperforming near term vehicles.

Generally the debt market will unwind the longest maturities first. As either supply exceeds demand or demand dwindles below supply the long maturities interest rates rise first. As the cycle plays out earlier and earlier maturities interest rates rise.

My best advice is patience and prudence. Don't be in a rush to be "fully invested". Keep a weather eye on the economy and the business cycle. If the recession looks like it going to keep invested money in the debt markets we may have to invest more than we like at less than ideal rates. Even in these situations the markets get giddy and sometimes offer us a couple weeks or months of good shopping. You hear stock advisers talk about buying on the dips. I think debt investors need to think about adopting that strategy. Keep more cash than we would prefer earning a pittance in order to capture those better moments. What is the best balance of cash to keep available? I don't have a simple answer for that.

There is hope, many banks need to raise capital and this first sale only put a dent in most of their needs. There may come a time, particularly if they are in a rush to get out from under the TARP program, that these banks will offer above average rates.

jack
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