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Marilyn Cohen, Forbes Magazine, 01.09.06

Surprisingly good yields, coupled with decent ratings, can be found with corporate bonds due to mature in the next few years.

Just when you thought the season's gift hunting was over, there's one last, postholiday item that should be on your list: corporate bonds set to mature in the next few years. They offer nice yields that are like a thoughtful gift. These yields are deliciously high compared with the returns from intermediate and long-term issues.

There is no reason for taking the interest rate risk on an intermediate term bond, such as a Fidelity Investments issue that is maturing on Oct. 30, 2015, to capture a yield of 5.4%, when another Fidelity Investments bond, maturing in only two years (Dec. 15, 2007), is yielding 4.9%. The difference in yield is minuscule.

What about future Federal Reserve hikes? Don't they make it too soon to buy? I think the risk of significantly higher short-term rates is minimal. The Fed, which in mid-December raised rates by a quarter-point to 4.25%, is clearly closer to the end of its tightening cycle than the middle. I believe that the next half-point of rate increases is already priced into debt securities.

One reason, though it's hard to see it now, is that this economy is just on the brink of slowing. How can I know? From what the pundits are saying. It's wise to bet the opposite. Recall the savants' gloomy talk in 2002 and 2003 about a jobless economic recovery. Well, job growth came along: In November a robust 215,000 jobs were created. Today the pundits are excessively optimistic. They see that rate increases since mid-2004 haven't slowed the economy and conclude that nothing will. Nonsense. Rate hikes have always slowed economic activity in the past, and this era is no exception.

Regardless of what the future brings, you can't go wrong gaining a little extra income from the high-quality corporates I have in mind. Since they mature relatively soon, you can reinvest in fresh opportunities that arise.

Take a look at Sprint Capital 6.375s due May 1, 2009, rated Baa2 by Moody's and A- by Standard & Poor's. This $750 million issue priced at 103.76 for a noncallable yield of 5.14% has the longest maturity of any of the offerings I recommend now.

Sprint's balance sheet has improved significantly since the telecom meltdown days. In June 2002 the two leading ratings agencies had Sprint one step away from junk: Moody's at Baa3 and S&P at BBB-.

Do not be dissuaded by what appears to be a tax disadvantage of premium bonds (namely, that you have high-tax-rate coupon income offset by a low-tax-rate capital loss). This disadvantage melts away if you do your taxes right. Instead of claiming the $37.60 price depreciation (per $1,000 face value) as a capital loss at maturity, claim it as a monthly amortization, an ordinary deduction against interest income. Your broker should be able to do the amortization calculation for you. If not, get a new broker.

What happens if the Fed stays on its unremitting march to higher rates? This catastrophe would cause very little damage to someone holding a short-term premium bond. It simply means that your bond premium erodes toward zero more quickly than you expected. You still get the coupon and the $1,000 maturity value you bargained for.

If bonds priced at a premium aren't for you, then look at Freddie Mac 5.05s due Dec. 8, 2008. Yes, Freddie was caught fudging income statements: It pushed profits into the future to smooth out earnings. Nevertheless, the $1 billion 2008 issue is rated a pristine Aaa by Moody's, AAA by S&P. The Freddie issue was recently priced at 99.80 to yield 5.26% to the Dec. 8, 2006 call and 5.12% to maturity. A three-year Treasury yields only 4.36%.

Assuming the Freddie bond will be called at year-end 2006, you may want something that will pay you longer, like the Fidelity Investments issue I mentioned. Fidelity Investments 6.75s due Dec. 15, 2007 are rated A1 by Moody's and A by S&P, and priced at 103.45 for a 4.9% noncallable yield to maturity. If the bond market does well, so will Wall Street's Fidelity Investments. If mergers and acquisitions keep rocking, so will Fidelity Investments. And if stocks keep on an upward trajectory, so will Fidelity Investments. Should they not, Bear is strong enough to pay you.

Still queasy about interest rate rises and want to put your money into something even shorter? Consider AT&T 6.50s due Nov. 15, 2006, which are rated Baa2 by Moody's and A by Standard & Poor's. Priced at 102.67, this bond yields 4.5% to maturity. You can't get that on a Treasury unless you go out ten years.

Rising rates spook investors, of course. But note that, unlike in periods following past Fed tightenings, intermediate and long-term rates have barely budged since the latest round started in summer 2004. So go where the good yields are.

Marilyn Cohen is president of Envision Capital Management®, Inc., a Los Angeles fixed-income money manager and author of The Bond Bible. Find past columns at http://www.forbes.com/search/results.jhtml?RD=DM&MT=marilyn%2Bcohen&date=&author=&sort=.