Our discussion today will focus on alternatives to keeping your money in fixed deposits.

As expected the United States Federal Reserve dropped the fed fund lending rate again on Tuesday, August 21, 2001. Chequing account and savings rates in the US have sunk to a low not seen since the early 1990s. Will that have a trickle down effect to the Bermuda economy? The answer is that it depends a great deal on what financial institutions can earn on their free cash, that is, the difference between mortgage lending interest coming in and fixed deposit interest going out. If the spread is too narrow for too long, it will impact profitability, and fixed deposit rates may be dropped again. It's like so many things in life, it just depends.

INDIVIDUAL SAVER

ACTION PLAN

So, what can you do as an individual saver to combat these low rates, at least, on a short term basis? You can consider using:

4 A money fund for liquidity (cash you need fairly frequently) instead of locking it up in a fixed deposit, subject to early cashout penalties;

4 High credit rated corporate bonds for their higher coupon (interest); or

4 Some shares of preferred stock, which pay quite a bit higher dividends than common stock.

Why would these types of investments pay a better rate than a time deposit? The answer is that, in good times and bad, businesses still need to borrow money, so they issue bonds and you, the investor, become one of their "loan officers".

To the average investor, these statements still may not make much sense. To better understand first why you can get a higher rate of return from bonds, go to www.bloomberg.com, click on markets and check out the interest rate sheets. Next to, or below the graph illustrating the yield curve, (Thursday morning) you will see that the fed fund rate is approximately 3.38 percent. The prime rate is standing at 6.5 percent, more than three percent above the fed fund rate. This is the rate that financial institutions and corporations use as a basis to determine what they will charge or pay interest on for loans, mortgages, bonds, and so on. This rate will almost always be higher, because when a company needs to borrow, the offering has to be more attractive than a bank or no one will bite. Still that does not explain why anyone would take the risk, although the precise point is that you can take risk wisely.

BOND RISK

Risk. Consider our own Ace Limited's recent ad statement "if you take away the risk, you can do anything".

Large and small corporations of all kinds can be literally rated for their capability to handle risk and pay back their debt. Very experienced global credit rating agencies such as Moody's and Standard & Poor's earn a very good living by scrutinising these companies for many components, including fiscal soundness.

Those with stellar reputations, and ACE Limited is one, receive high credit ratings - such as AAA, AA or A. Their bonds, secured and unsecured, are very much desired. No wonder, investors feel comfortable purchasing them, because even though they are not guaranteed (like a fixed deposit may be) the company liable to repay the bond interest and principal is fiscally solvent.

Conversely, junk bonds from companies that are very unstable and may have very low ratings usually pay, in the ultimate twist, the highest interest rates. They have to, they want investors to 'take a chance' that they will pull out of the mess they are in. Remember the flamboyant Donald Trump? He was so heavily in debt with his casinos leveraged to the hilt that Trump junk bonds were paying a yield of about 20 percent . Most thought he would hit bankruptcy row, and he almost did. So you must be careful which type of bonds you invest in. How credit worthy are they? Remember, generally, the higher the coupon interest rate the lower the bond rating and the higher the risk you may not get your principal back. Always ask for the company bond rating and stick to bonds rated in the A group, that is A, AA or higher.

OUR FRIENDS,

THE PREFERREDS

Corporations also raise capital by selling you a piece of their company in the form of preferred stock. Preferred makes it sound real special, doesn't it? But, in reality preferred shareholders are just not that, at all. Unlike common stock shareholders, they have no voting rights, or say in certain aspects of how the CEO and the Board of Directors handle company issues.

For instance, common stock shareholders (owning small numbers of voting stock) have formed powerful groups by using the gathering capabilities of the Internet. They have then lobbied in large numbers to have excessive compensation taken away from CEOs who have managed so poorly that some specific company, say Sunbeam, is on the verge of collapse. Of course, that practice still goes on today! The top two executives of Lucent were awarded 'golden parachutes' as they left this struggling company, while stockholders, both employees and investors watched the market value drop by 80 percent. In general, the two preferences that preferred stock does receive is a higher paying dividend, and the right to receive this dividend before common stock shareholders get theirs.

To make these shares appealing, companies pay much higher dividend rates, and place preferreds higher in the pecking order of any dividend declared. See the chart on the pecking order of payment of liabilities in a corporation, which is liquidating.

Next week, we pick apart these investments and discuss where and how to purchase them.

Martha Harris Myron CPA CFP, is a Bermudian, an NASD Series 7 licence holder, a United States Tax and a Comprehensive Financial Planner practitioner. She is Education Director for the Financial Planning Association of Bermuda(FPAB). Martha Myron received the Bermudian Bermuda Gold Award for Best In Bermuda Investing Advice.

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