You are at a children's playground.

Picture a giant see-saw, you know the ones that have been in play grounds and Mother Goose nursery rhymes since time immemorial. Sitting in the very middle of one of the seesaws on the pivot point is Jeb Woodbeam, CEO, of Creative Carpentry Products, a NASD publicly listed manufacturing corporation (CCP).

Jeb's company manufactures wood products, specialising in outdoor furniture. Business has been good, so good, in fact that CCP is expanding into global markets, and needs to raise capital to increase its production. Jeb Woodbeam, no relation to Jeb Bush, the Governor of Florida gearing up for campaign against former attorney general Janet Reno, is an excellent CEO. He runs a tight profitable fiscally conservative company. CCP has just received an AA credit rating from Moody's, a bond and company rating service.

What this little nugget of information signifies to capital market analysts and investment managers, is that the repayment rate on any security issue (bonds) purchased from this company is almost guaranteed to be repaid, on time, every time for as long as they remain a viable stable company. CCP decides to float a $300 million bond issue paying a coupon rate of six percent annually, in $1,000 coupons, with a maturity date of 2004, but callable in year 2002, and rated AA. CCP figures this will give them enough additional cash flow to increase market share abroad, plan a five year strategy operation, and generate far more revenue than the six percent interest expense they will have to pay each year to every bond holder.

The investment bankers and underwriters are selected; everyone is excited, lots of money to be made (and spent). The issue floats, the bond sale is successful, even you have been able to purchase ten bonds at $1,000 each!

And Jeb, still sitting on the seesaw, today he is a happy man; his company has realised about $280 million from the bond offering, all of which sold. And, why not? In this low interest rate environment a bond with a coupon rate of six percent looks good; investors, large and small, have snapped them up. Wait a minute, where is the rest of the money? Ah, that went to the investment bankers, you did realise they have to earn a living, too. Also, their Porches and Lamborghinis are getting old and they need to trade up. Increased business for everyone, good for the whole business economic cycle.

Jeb is also pleased to tell you that no matter which way interest rates and capital markets move, up or down and down or up, he, personally, and his company will still pay your bond coupon interest at an annual return of seven percent to you, and when the maturity date is up in 2004 , you will be paid back the $1,000 principal. That fact does not change, but note, watch the seesaw when interest rates fluctuate. Bond coupon rate interest is not the same as bond yield.

For those reading the column for the first time, and regular readers, hopefully, it should be obvious by now that we are in the pretend mode. Essentially, Jeb Woodbeam, CEO, and his company (CCP) are concoctions, teaching aids, if you will.

Bonds are often classified in investment articles as being very risky, very volatile, but generally safer than purchasing stock. The classic textbook description of a bond is:

A debt security, which obligates the issuer (CCP) to pay interest (usually semi-annually) and to repay the principal amount when the debt matures.

Bond prices react to interest rate swings, in the opposite direction. So the fear is that if you have to sell your bond before it matures, you may not receive all of your principal back. Why not?

Back to the seesaw, and Jeb Sitting In The Middle. He promises to pay you seven percent until the bond matures, no matter, which end of the seesaw, is up.

In real life, suddenly, the markets become very volatile and interest rates at financial institutions are now at 8.5%. You paid $1,000 for your bond, but you want another one that pays nine percent. How much do you think you can get right now for your seven percent bond? $1,000 face value - not a chance, you will have to reprice your bond to sell at a discount, perhaps $850, because everyone is now seeking higher returns. At a discount, your bond will sell to someone, because the new investor will still get $1,000 principal back when the bond matures. The profit of $150 dollars (1,000-850) when the principal is paid back in 2004 offsets the lower interest rate being received.

So what is the bond yield for the new investor? It is a combination of the coupon interest rate of seven percent and the profit on the discount paid. Because market interest fluctuates every minute of each day, a bond's yield is always calculated against what price it can be purchased for at that moment, using the same logic. Coupon rate of say seven percent, plus the discount profit (computed math now) or if the bond can sell for more than $1,000, the coupon rate of say seven percent minus the premium loss.

Think of the seesaw routine again and picture it going up and down, up and down - when market interest rates rise, bond prices drop, when market interest rates fall, bond prices rise - but the coupon interest stays the same. If you have paid a high price now for a high interest rate bond, you have paid a premium, that is more than $1,000 for each bond, say $1,090. If interest rates rise quickly, as they might, and you want to sell out, you may be forced to sell at a deep discount, that is even less than $850. See the example above and do not be caught off guard.

But what if you do not ever sell your bonds?

What if you keep your bond to maturity in 2004?

You will receive your interest payments annually (if the company stays solvent - it should it is rated AA) and your principal at the end.

Simple, don't you think?

This strategy actually works very well for many living on a fixed income.

They need the income from the bonds, and generally do hold them to maturity.

How would you make that decision? Well, it is not easy.

What happens if your bond is callable?

CCP has the right to "call back" (buyback) their bonds in 2002.

Why would they? If market interest rates rise, they may not.

After all, they have cheap loans on the books, but if interest rates drop to, say 4.5 percent, you bet they will take them away.

CCP knows they can refinance again, offering 4.5 percent interest bonds and do very well.

Can you refuse to return your callable bonds?

Sure, but CCP can refuse to pay you any more interest.

Preferred stocks pay very nice dividends.

We discussed them last week; request the article from The Royal Gazette if you would like to revisit those investments.

Preferreds may often have a call feature attached, and the theory works the same way as the callable bond description above.

Companies must protect themselves against rapid changes in interest rates, in order not to be saddled with unreasonable interest or dividend payments.

And finally, what about those really high yielding junk bonds, such as the ones that Donald Trump Enterprises float?

Last time I perused the Wall Street Journal, why there he was.

Er, not him, but Trump junk bonds were paying interest of 15 percent and selling at a deeply discounted price of $700 (instead of around $1,000).

And there you go, now I have totally confused you.

But, these are junk bonds rated less than B, sometimes C or lower, see our rating discussion last week.

The Donald has to offer you several "sweeteners" in order for you to take the hook.

And there are two large pieces of bait, a 15 percent annual interest rate pay out and when the bond matures in 2020, you will receive $1,000 principal back for a profit of $300.

Will The Donald still be around in 2020, with any money?

Will you? Who wants to bet?

What can happen if you choose a very long maturity date?

Well, its another day for another article, but simply put, you can always sell the bond early.

Question is, what will you get?

Read the fine print and work with an experienced financial advisor.

Martha Harris Myron CPA CFP, is a Bermudian, an NASD Series 7 license holder, a United States Tax and Comprehensive Financial Planner practitioner.

She is Education Director for the Financial Planning Association of Bermuda(FPAB).

Recipient - 2001 The Bermudian Bermuda Gold Award for Investing Advice.

The opinions in this column are the author's alone and are not endorsed by any organisation.

Under no circumstances are the comments in this column to be taken as specific recommendations on the purchase or sale of securities or any other investment.