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Cents and Sensibility

BY GUY STEELE

Saturday, November 3, 2001



Bankruptcy can be
costly to stockholders

QUESTION: When a publicly traded company files for bankruptcy, what happens to its stock and stockholders?

ANSWER: Unless the company can reorganize or be absorbed into a larger, profitable corporation, the stock certificates can be used for wallpaper or a conversation piece: they'd be valueless.

If the company goes out of business and its assets are sold in a liquidation, by law, creditors and bondholders are paid first. Any remaining funds would be dispersed among the owners (stockholders) of the company.

While in bankruptcy reorganization, a company's stock may still trade on an organized exchange but most likely at pennies on the dollar.

Q: What is a callable bond?

A: A callable bond, like any type of corporate bond, is issued by a company to raise capital. When you purchase a bond, you are simply loaning a company money. In return, the issuing company promises to pay you a stated rate of interest for a specific amount of time.

With a callable bond, the company issuing the bond reserves the right to call part or all of a bond issue and pay off its debt before the bond's stated maturity. This means you may not continue receiving regular income from your bond as long as you originally anticipated.

To compensate investors for assuming this risk, callable bonds often pay higher yields than noncallable bonds. In addition, some callable bonds guarantee a premium call price, which means you receive more than the face value of the bond if it's called early.

When considering callable bonds, remember this: Longer periods of call protection and higher call price premiums benefit you, the investor.

If you decide to invest in callable bonds, it's important to be aware of a couple of things. The first is reinvestment risk. Callable bonds are usually called following declines in interest rates. Companies call their original bonds and reissue new bonds at a lower rate of interest to lessen their debt. Unfortunately, this means you may be forced to reinvest your money at a lower rate of interest.

On the flip side of the coin, if interest rates rise, callable bonds would most generally not be called. The market price of the bonds, like all fixed-income securities, will decline in value.

So, should you invest in callable bonds? As always, balance is the key. Most portfolios should include both callable and noncallable bonds. A combination of the two will provide more attractive yields while lowering your reinvestment risk.





Guy Steele is a financial planner and head
of the Pali Palms office of Edward Jones. Send
planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, HI, 96734,
or by email at: gsteele2@pixi.com




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