now might be the time to purchase a few bonds or bond funds for the mock portfolio.

We have picked a bond fund and a single company bond.

What are bonds? Just the opposite of stocks! When you purchase even one share of a company stock, you own an equity piece of that company and as a minority owner you have certain rights such as voting for the Board of Directors.

When you buy a bond or a bond fund, you are loaning money to the bond issuer, such as a corporation, a municipality, or the government.

You are actually holding their liability to you. For them, it is one way to raise capital, generally, without giving control to a shareholder.

Some companies sell their stock and their bonds to the investing public.

Locally, for instance, the company that built the new wharf at the Royal Bermuda Yacht Club and the Bermuda Housing Corporation both floated bonds.

They expect to pay bondholders back both principal and interest from net revenues earned from lease or sale of these properties.

Thus, a bond gives you a contract that the issuer will pay you a fixed rate of interest over a set number of years and at the end of that time (maturity), the return of principal you loaned them.

If the bond issuer is a very large well capitalised corporation, they may pay a decent rate of interest, but not a spectacular one; however, you have pretty good assurances that this corporation will not default on its loan payments to you.

Strong stable companies issuing bonds generally will receive a very desirable rating by a bond rating agency, perhaps somewhere in the AA category.

What about Junk Bonds? Many other types of companies need to raise money also.

Their financial history may not be as long, as strong or as stable as large well-capitalised corporations. That's why they are issuing bonds in the first place, to increase the amount of capital (even borrowed) in order to expand, launch a new product and so on. Because these companies have a risky history, in order to attract investors, they go for the money, by issuing bonds that pay a much higher rate of interest than conservatively rated bonds.

Is this more risky, you bet? Investors know they are betting on the company cashing in big-time.

If it doesn't, it may actually default on its payments to bondholders. Worst case, it may file for bankruptcy.

Even though, you the bondholder are technically first in line to be paid out of the company's remaining assets, you may lose your entire stake.

Rated much lower on the bond grade scale, perhaps, B- or even C-, these are also called junk bonds, and justifiably so.

How do you buy a bond? Pretty much the same way you buy a stock. Generally, bonds are sold in $1,000 dollar increments in a coupon-type form.

Printed on the face of the coupon is the interest rate that the bond will pay, and the date the bond matures.

Example: a 6.5% bond due in February 15, 2004, will pay you $65, usually twice a year ($32.50).

As longer as the company is solvent, no matter what happens to the market, you will receive that interest payment.

Bonds are also known as negatively correlated with interest rates.

You very often see in market reports negative indicators concerning the movement of the bond market.

That is because their value (yield) is highly sensitive to interest rates changes, both up and down.

Example: 1 -- Bonds sold at a discount.

You purchased your $1000 bond at 6.5% interest due to mature in Feb 15, 2004, about six months ago when interest rates were at say 5%. The Federal Reserve has now raised the fund rates (the rate banks lend to each other) which means that banks will now charge about 2 percent more to loan money out. Suddenly, if you wanted to sell your bond, you would have not any takers at your asking price of $1000. Why? Because many other types of investments are now going to pay higher rates than 6.5%, so your bond is out of favour.

But you really want to sell it NOW. Into the deal walk the free market forces and just like any merchandise not wanted, your bond is marked down, discounted, to $800 and it finally sells.

You have accepted a loss of $200 in order to make your money work harder in an investment returning a better rate of return.

The new bondholder will still get 6.5% interest annually ($65) paid from the coupon rate, but the his /her real rate of return is (quick, do the math) 8.13%! Why? Because he /she paid less than the coupon rate /face rate of $1000, so this actually increases the rate of return ($800 X 6.5% equals $52) Example: 2 - Bonds sold at a premium.

Now, let's say that Company X decides to issue bonds tomorrow. They really want to be competitive and sell them quickly, so these bonds pay a coupon rate of 9%. This is a limited issue; every one wants them and the price goes up, over the $1,000 face amount to $1,120 for each! Why, because these bonds are paying MORE than the current market interest rates.

Guess what the real rate of return (yield) is -- 8%! Isn't it amazing how the free market works! The person who paid the premium for his bond actually will has a yield lower than his interest payment because he paid more. Think about it this way, compute 9% on $1,120 equals $100.80 per year, but he /she will really get $90 per year.

What finally happens? The investor who bought the 6.5% bond at a discount is hoping that interest rates will drop below 6% and he can resell his bond at a premium, making more than he paid ($800).

And the investor who had to have the 9% bond paying a premium, also hopes that interest rates will drop, so he can sell his at a premium above what he paid.

Keeping your bond until the maturity date.

And the entire explanation above on the swing of bond discounts and premiums has no effect if you buy a bond AND HOLD IT UNTIL IT MATURES. However, many bond and bond products are sold with 10, 20, 30-year maturity dates.

No one can predict what interest rates will be that far out on the horizon.

This interest rate uncertainty brings another whole element into the equation, to be discussed later.

For today, simplistically stated, this is a primary lesson on bonds. You should know that this type of movement in the bond market goes on every second, every trading day.

It sounds complicated, but it really isn't, just a little more in Economics 101, the law of supply and demand.

Why buy bonds? Because they don't ordinarily move in the same direction as stocks, that is, when the value of stocks drop, bond values may rise; because bonds typically pay higher interest rates than fixed deposits; because highly rated bonds are safer than most stocks; because they pay income out and preserve principal; and because they constitute part of a diversified portfolio.

Allocating your investment resources using money laddering and the see-saw effect will be much talked about in the coming months.

Martha Myron CPA CA is a Bermudian, holds a Series 7 NASD license and is a United States federally authorised tax practitioner. She is Programming Chair for the International Association for Financial Planning/Bermuda. Questions regarding this article may be sent to her at 234-0290 or Email: marthamyron y northrock.bm