ALAN S. MOORE / L’Observateur / August 18, 1999

When you receive your account statement from your investment portfolio each month or quarter you may wonder why the market value of your fixed income securities varies. Fixed income securities, or bonds, are generallyconsidered to be more conservative investments than equities and you may expect there to be less price volatility from the fixed income portion of your portfolio. Similar to most financial markets, there are often pricemovements within the bond market that may cause the value of an individual bond to be different than the price at which it was purchased.

There are several factors that may alter the value (or price) of the bond including change in the level of interest rates, change in the credit quality of the issuer and the maturity of the bond.

If you intend to hold your bond to maturity, the price swings in the bond market should have little impact, as you will receive the face amount of the bond on the maturity date. Fluctuations typically affect thoseinvestors who plan to sell their bonds prior to maturity.

Interest Rates One major factor that affects bond prices are changes in interest rates.

An inverse relationship exists between a bond’s price and its yield. Asinterest rates rise, bond prices typically fall to bring their yield in line with the higher yields available in the market. For example, if the currentinterest rate in the market for a 5-year bond is 6 percent, the investor will probably pay par ($1,000) for a bond that has a coupon rate of 6% (or $60 per year in income from coupon payments) and matures in 5 years. Ifprevailing interest rates rise to 7 percent, the 6 percent bond will be worth less because an investor can pay par for a bond that pays a higher rate of interest than the one the investor currently owns. Therefore, the6.00 percent bond will most likely trade at a price below par or at adiscount.

Conversely, as interest rates fall, bond prices typically rise to bring the yield in line with the lower yields available in the market. Consider thesame bond in the previous example. Assume prevailing interest rates fallto 5 percent, then the 6 percent bond will be worth more due to the higher rate of interest earned by the bondholder. As a result, the value of thebond will most likely rise above par and will trade at a premium. Sincebond prices fluctuate with the movement in interest rates, it is important to note that the value of a bond sold prior to maturity may be higher or lower than the purchase price.

Credit Quality The credit quality of an issuer can also play a role in determining a bond’s value. In general, credit quality is the ability of the issuer to makeinterest and principal payments on time and in full. If the credit qualityof an issuer begins to deteriorate, the value of their bonds could decline.

On the other hand, if the credit quality of an issuer begins to improve, the value of their bonds may increase. In addition, lower credit quality bonds(below investment grade or non-rated bonds) will usually have more price volatility than higher quality securities.

Maturity There is also a link between a bond’s maturity date and price. A bond witha longer term to maturity than another security will generally fluctuate more in price. Since the issuer must make interest payments over a longertime period for a 20-year bond versus a 5-year bond the risk of not receiving payments is higher. As a result, an investor is usuallycompensated for this increased price variation with higher yields.

The value of the fixed income securities in your investment portfolio will probably vary from month-to-month. Price swings in the bond market areundoubtedly bound to happen, as the level of current interest rate changes.

In addition, the credit quality and term to maturity can also affect the value of the bond. It is important to consider all of these factors, in lightof your investment objective, when evaluating the fixed income securities in your portfolio.

(Alan S. Moore is a financial advisor of Legg Mason Wood Walker, Inc., adiversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc. and SIPC.)

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