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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35345  
Subject: Re: Fixed Strategy Date: 1/14/2005 2:18 PM
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This is a very complex subject, Stephen.

At a basic level, bonds are a commodity product. Say two banks are on opposite corners in your neighborhood. One offers 3.5% on your passbook savings. The other offers 4.0%. Which do you choose? Most will choose the higher yield, but other factors such as safety, the banks reputation, personal relationships, past business with one or the other, etc, etc, can cause you to make exceptions.

Thousands of bonds are available out there. They are rated by reputable firms. Those of equal rating and term are supposedly identical. Hence, ultimately market factors and market prices determine the price you pay and the yield you get.

When interest rates change, new buyers have available plenty of other bonds at the new interest rate. Yours pays a fixed, specified interest payment. Its market value must be adjusted to offer the market interest rate to make it competitive. Hence, its market value changes.

"So, if I am holding a bond, and the market is weak, can I assume that the value will increase as demand goes up, while if interest rates are increased by the Fed, the price will then drop?"

This statement is a bit off the mark. At the instant interest rates go up, the market value of your bond theoretically decreases. Market forces can bid it somewhat higher than that discounted value if demand is strong (not weak). That effect has been observed recently, but it is not guaranteed to occur or common.

Generally all stocks that pay high dividends (all yield stocks) are owned by investors who think yield is important. Market forces tend to be at work. Yield stocks tend to respond to interest rate changes, but some more than others.

On preferred stocks, with interest rates very low, keep an eye on call prices. Many high yield preferred issues pay high yields because their current market prices is above the call price. This means the shares can be called out from under you at less than what you paid for them. Many preferred stocks are callable at $25, some at $10. Investigate very carefully any paying high yields that sell for just over those figures. Check out the preferred stock list in the Wall Street Journal. Most high yield issues are priced over their call price. (Others like the airline preferred issues pay high yields because of uncertain financial prospects.)

Good luck.
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