Friday 31 July 2009

"Long-term Bond of the Future"

This may be a good place to make a suggestion about the “long term bond of the future.”

  1. Why should not the effects of changing interest rates be divided on some practical and equitable basis between the borrowers and the lender?
  2. One possibility would be to sell long-term bonds with interest payments that vary with an appropriate index of the going rate.
  3. The main results of such an arrangement would be: (1) the investor’s bond would always have a principal value of about 100, if the company maintains its credit rating, but the interest received will vary, say, with the rate offered on conventional new issues; (2) the corporation would have the advantages of long-term debt – being spared problems and costs of frequent renewals of refinancing – but its interest costs would change from year to year.

Over the past decade the bond investor has been confronted by increasingly serious dilemma:

  1. Shall he choose complete stability of principal value, but with varying and usually low (short-term) interest rates?
  2. Or shall he choose a fixed-interest income, with considerable variations (usually downwards, it seems) in his principal value?

It would be good for most investors if they could compromise between these extremes, and be assured that neither their interest return nor their principal value will fall below a stated minimum over, say, a 20-year period.

  1. This could be arranged, without great difficulty, in an appropriate bond contract of a new form.
  2. Important note: In effect the U.S. government has done a similar thing in its combination of the original savings-bonds contracts with their extensions at higher interest rates.
  3. The suggestion we make here would cover a longer fixed investment period than the savings bonds, and would introduce more flexibility in the interest-rate provisions.

Ref: Intelligent Investor by Benjamin Graham

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