Now could be a good time to pick up some junk-bond funds

ByABC News
September 1, 2007, 4:35 AM

— -- Want to be the most popular person on Wall Street today? Put in a bid for a junk bond. Junk-bond prices haven't collapsed, in part because everyone is too scared to trade them.

If you own a junk-bond fund, it's probably too late to sell. You might consider adding to your holdings over the next few months, though.

Remember, bonds are long-term debts that you can buy or sell. A $1,000 30-year Treasury bond is a $1,000 loan to the U.S. government. If you had bought your $1,000 T-bond when the government sold it in May, you'd receive 5% interest, or $50, every year until May 2037. At that point, the Treasury would return your $1,000 principal.

If you buy the bond now, though, you'll pay more than $1,000. Why? Because bond traders think long-term interest rates will soon fall. If rates fall to 4.5% at the next Treasury auction, your 5% T-bond will suddenly look mighty attractive.

A bond's interest payment is fixed, which is why the bond market is sometimes called the fixed-income market. Traders can't change your bond's $50 annual payout. Instead, they'll push your bond's price up or down to adjust its yield the interest payment divided by the price. If your T-bond's price moved up to $1,100, for example, its yield would fall: $50 divided by $1,100 is 4.5%. Conversely, if your T-bond's price fell to $900, its yield would rise: $50 divided by $900 is about 5.6%.

The Treasury is considered the safest borrower on the planet; a default would be unthinkable. When you deal with corporate bonds, however, you do have to think about default. If you buy a 30-year bond issued by the fictitious International Infindibulum, for example, you have to wonder whether the company will be able to repay its junk-rated debt.

Wall Street employs legions of people to determine a company's ability to make timely interest payments on its bonds and to repay principal once those bonds mature. Companies with good credit ratings pay a bit more interest than the Treasury does. (Their credit is good, but they're still not the U.S. Treasury.)