Corporate bonds.

Do you remember the '80s, when getting high returns was simple? It was the era when 30-year Treasury bonds were yielding 14% to 16% and local banks were offering returns of 9% on certificates of deposits (CDs) and money-market accounts. Well, those days are over. By the end of last year, 30-year Treasuries had been slashed to single digits. And the return on a one-year CD was a paltry 3%.

The flip side is that the Federal Reserve Board's monetary ease sparked a rally in the bond market in 1991. Bonds had gained double digits, turning in their best performance in six years. In fact, the total return on Merrill Lynch & Co.'s Domestic Master bond index for 1991 was 15.85%, the index's highest return since 1985 (22.4%). The Domestic Master bond index monitors Treasury, agency, mortgage-backed and investment-grade corporate bonds. Total return measures interest income and price changes.

Should investors now worry about a faltering bond market? Some experts say yes. The performance of the bond market runs counter to interest rates. So, when interest rates fall, the value of bonds increases and vice versa. Already, rising interest rates have meant bad news for the bond market. By the end of the third quarter of this year, bonds were showing negative returns.

However, forecasts tell yet another story. As long as the economy's recovery is slow, interest rates will stay low. Rates will rise the rest of the year, but they won't reach the 9% level of the mid- and late '80s, say several experts.

Substantial Returns, Limited Risk

Little if any progress should be expected in the outlook for the federal deficit this year, thus, sustaining supply pressure on interest rates, says Pierre Dunagan of Dean Witter Reynolds, Inc. in Matteson, Ill. The strength and the duration of the business recovery will dictate if interest rates move above 8% for fixed-income investments.

Investors who are looking to acquire competitive returns without exposing themselves to substantial risk ought to consider corporate bonds. Committing a portion of an investment portfolio to bonds from companies with excellent credit ratings could be lucrative in the long run.

When you buy corporate bonds, you essentially are lending the corporation money for a specified period of time. Upon purchase of the bond, you are considered a creditor. Unlike stockholders, bondholders can sue the issuer if it does not pay interest on the bonds via its trustee.

Most corporation issue bonds to secure the capital they need to construct a new plant, purchase equipment, retire old bondholders (refunding) or even to acquire another corporation. Companies can raise large sums of money by borrowing from thousands of investors via bonds.

Bond Buying

The best way to check a company's insolvency is to get it bond rating from such services as Standard & Poor's and Moody's Investor Service. The rating will tell you the financial ability of the corporation to repay your principal and pay its interest in a timely manner.

[TABULAR DATA OMITTED]

One of the most important themes that has been developing over the last three years is the continuing improvement in credit quality, according to Fixed-Income Digest, a publication of New York-based Merrill Lynch, Pierce, Fenner & Smith Inc. Fixed-Income Digest reported in March that corporate balance sheets were improving as more companies reduced their debt burdens, either through refinancing at a lower rate or through the use of the equity market to raise capital.

Merrill Lynch recommends investors to concentrate on long-term securities of single A-rated industrial companies and select banks and finance companies. Any bond rated A (top quality) means the issuer's capacity to pay back interest and principal is strong. Top-quality bonds are referred to as investment-grade bonds. A medium quality rating (B and below) means that the repayment of these bonds is questionable, and they may be more vulnerable to adverse market conditions.

In addition, the higher the rating, the lower the coupon (interest) the issuer will pay. Obviously, the more the risk, the more the issuer will pay to entice investors. So, an investor would do better to invest in an AAA-rated bond with a 7% coupon as opposed to a B-rated bond that has a 7% coupon. There is a stronger possibility that the investor won't receive any principal with the latter. On the other hand, if a B-rated bond were to offer a yield of 13%, an investor may elect the higher interest as a means of compensating for the higher risk.

It's not as much the nature of the bond as it is the issuing corporation that's key. A company's earning power is considered a much better protection against the possibility of default than the right to take over its assets. If a company's earnings decline, the bond won't perform well.

Sizing Up

Your Return

As of March, the most expensive issues in the longterm corporate sector are those of electric companies. And the telephone sector in general is overvalued.

The return on your bond issue may be much more or less than the bond's coupon rate. Whatever the issuer has agreed to pay you, it will pay. If the issues have an 8% coupon on your bond, for instance, your interest per year will be $80.00 (8% x 1,000 face value). But remember: A bond's current yield reflects the price you've paid for the bonds and not the return you get.

Company XYZ has bonds with a coupon of 8% and is priced at 100. Interest rates fall to 1% and XYZ bonds rise to 110. If you bought the bonds at 110, now your current yield would be 7.3% ($80 interest)--$1,100 (the price you've paid for the bond). Company XYZ is still paying 8% or $80 interest; however, you won't be getting 8% because you've bought the bonds at a higher price. Conversely, say interest rates were to rise 1%, the price on XYZ bonds would have to fall to be competitive. If XYZ bonds fall to 90, your current yield would be 8.8%. Again, XYZ is still 150, paying 8%. Since you bought the bonds at a lower price, your current return is higher. Remember when interest rates drop, bond prices rise.

With interest rates not expected to rise much more by year-end, corporate bonds can still provide a safe alternative to CDs and money-market accounts, say experts. Investors may not get the same value as last year, but that doesn't mean corporate bonds won't provide excellent yields.