All You Ever Wanted to Know About Bonds

Warning: Fixed-income investments during periods of inflation may be dangerous to your wealth.

Considering the highly leveraged state of the American economy, it is truly remarkable that so little understanding of fixed-income investments exists today. Nonetheless, there has been a growing interest in recent years in the whys and wherefores of bonds, partly because of the huge volume of new issues that has come to market and partly because of the historically high level of interest these bonds are paying.

The total domestic demand for credit in 1973 was over $170 billion of which well over $60 billion was in the form of marketable corporate and government debt. This was an addition to over $500 billion in already outstanding marketable debt which was at least theoretically available to the prospective bond purchasers in the secondary market. In 1973 approximately $15 billion in newly issued bonds was taken down by individual investors. All of which indicates that a substantial investment alternative to stocks, real estate, gold, silver and other commodities is in existence. The objective of this article is to provide the reader with a brief overview of this alternative market. It is an analysis of the various opportunities open to an individual within the market for fixed-income securities. It is mute on the question of whether or not bonds are an attractive alternative within the entire investment universe. The reader can make that judgment for himself, hopefully with the above "warning" in the forefront of his thinking.

Until very recently the market for fixed-income securities has been distinctly unfriendly to individual investors. Individuals, in order to enter the debt market, have had to give up significant amounts of both yield and marketability. The advent of bond mutual funds has gone a long way to alleviate this problem, albeit with the creation of some new problems of their own. While access to the bond market has been made easier, the acceleration of inflation since 1965 has made the market considerably more treacherous.

The fixed-income investor has a myriad of alternatives available. He may buy long and short term debt issued by industrial corporations, public utilities, railroads, the Federal Government, state and local governments and banks. In addition to the issuing entity and the maturity date, a bond buyer must choose between a spectrum of coupons on outstanding debt ranging from as low as 0.5 percent to over 11 percent. How does one go about determining which of the literally thousands of outstanding bonds represent the best values for a given objective? We will examine the components of the bond market after a short discussion of the theory of interest rates and inflation.

INTEREST RATES AND INFLATION

In a free economy interest rates and, hence, bond prices are determined by the value of time. The lender is willing to forego the use of his capital during the term of the loan at a given price. The borrower, in turn, is willing to pay that price (the going market rate) because he believes he can realize a higher return on the capital than he must pay to borrow it. It is in this manner that capital is put to its most efficient use by the mechanism of a free market. The time value of money is itself a function of the real marginal productivity of an economy and the real rate of savings.

Given the hypothesis of a free economy (which entails no government control of the quantity of money) interest rates would fluctuate only very gradually and there would exist a slightly positive yield curve reflecting the increased risk involved in lending money for longer periods of time. Chart I illustrates the point that fluctuations in rates would occur primarily at the short end of the yield curve, acting as a self-regulatory device which would discourage over-investment and prevent the cyclicality that is associated with so-called "mixed economies."

Because we do not have a free economy in the United States interest rates fluctuate violently throughout the yield curve. In adversity, however, there is opportunity. The bond market is not a particularly efficient one today, partly due to these fluctuations. At any point in time there exists self-evidently over and under valued bonds. The astute bond investor who can take advantage of the inefficiencies in the market stands to gain quite a bit more than just the "going rate of interest" from his investments. But we're getting somewhat ahead of ourselves.

Any analysis of bonds in today's economic environment must include a discussion of inflation. It is unfortunately true that inflation is the single most important factor to be considered by anyone contemplating fixed-income investments. Inflation has been blamed on everything from coercive labor unions to greedy businessmen. The real cause is government printing presses. As long as the government possesses the monopoly granted it through the Gold Reserve Act of 1934 and the legal tender laws (which prevent competition with the government in the minting of coins or printing of paper currencies and force the acceptance of fiat money in settlement of debts) it has the means of controlling the quantity of money and the extension of bank credit through the Federal Reserve System. Because of this the inevitability of inflation is assured.

The scenario is a simple one. Politicians need votes to get elected. They can get votes by promising something for nothing to the voters. When it comes time to produce the something the politicians have three choices to finance their favors. They can increase taxes, they can borrow from the public or they can steal from the public by printing currency. In practice, of course, all three methods are used but the last one is by far the most popular because it is the least obvious and the most effective. It is also the only one which creates inflation.

Simply stated, when more dollars are chasing relatively fewer goods and services the price of those goods and services will rise. Until very recently most economists and investment analysts were oblivious to the causal relationship between the quantity of money and inflation. They accepted the erroneous Keynesian explanation of inflation as strictly a "cost-push" or "demand-pull" phenomenon that was an inherent element in the cyclicality of a"free" economy but which could be controlled through discretionary fiscal action on the part of Government.

Why does inflation, caused by an increase in the quantity of money, lead to higher interest rates? There are three separate and distinct effects on interest rates caused by an addition to the quantity of money: the liquidity effect, the income effect and the price expectations effect. These have been documented by Gibson [1] and Sprinkel [2] in separate works, as well as by others.

Says Sprinkel concerning the liquidity effect: "The conventional Keynesian analysis of the effect of an increase in the money supply on interest rates argues that to induce money holders to voluntarily hold an increased supply of money, interest rates must decline. Until recently, most economists would have used only the above version in explaining the impact of a changing money supply on interest rates. Some would have argued that the very forces by which the money supply increases in our economy, i.e., largely open market purchases of Treasury bills, leads to higher prices for Treasury bills and ultimately to lower rates on other assets as portfolios are adjusted to the lower Treasury bill rate. This analysis is indeed correct so far as it goes, but it stops much too soon and, in fact, misses the major effect of a changing money supply on interest rates." [3]

The second and briefly delayed response to the new money in the system is an increase in incomes resulting from increased spending. The tendency of this income effect is to raise interest rates back to the same level that existed prior to the influx of money. The relationship between savings and investment will have reached its previous equilibrium level.

The price expectations effect is the final and most important influence on interest rates and the one that is completely ignored by Keynesians. Once a reasonably full employment of resources has been attained in the economy the income effect will drive prices higher, thus reducing the purchasing power of the dollar. Lenders, recognizing that the real value of the money they are lending is greater than what they are receiving when the loan is paid off, will demand a higher rate of interest to compensate. The longer prices continue to rise, the greater the impact of the price expectations effect is on interest rates and the further out along the yield curve interest rates are increased. Chart II, which shows the consumer price index and the money supply, tends to confirm the price expectations theory of interest rates.

Armed with the knowledge that inflation is bad for bonds, we can now venture into the real world of bond investing. There are three basic means by which an individual can intelligently participate in the long term bond market: municipal bonds; bond mutual funds; and selective purchase of unreasonably depressed corporate bonds. Short term debt instruments will be discussed later.

TAX-EXEMPT BONDS

Many investors who do not have the time or inclination to do otherwise adopt a simple "buy and hold to maturity" approach to the bond portion of their investment portfolio. Those who do so should at least be concerned with the after-tax return that the bond provides. Since the debt issued by state and local governments is not subject to federal taxation [4] it most often is the appropriate vehicle for this type of investment policy. Chart III illustrates the yield a taxable bond must provide to equal the after-tax return on a municipal bond based on 1973 federal tax rates for those filing separate returns.

The specter of some individuals earning income exempt from taxation has, predictably, aroused the ire of politicians seeking to fatten the public coffers. Since the passage of the Federal Income Tax Law in 1913 the Internal Revenue Code has contained a section exempting from taxation the interest received on "the obligations of a State, a Territory, or a possession of the United States, or any political subdivision of any of the foregoing." [5] The federal government has recently increased its attacks on this exemption in the name of "tax reform" and the prudent investor would do well to keep an eye on pending legislation in Washington that would affect the status of tax-exempt bonds.

Because subjecting municipal bonds to federal taxation would increase the cost of borrowing for local governments (and thereby pit politician against politician) it is probably safe to assume that the federal government will "reimburse" the municipality under whatever plan is adopted. The key factor to watch out for is the status of interest on outstanding tax-exempt debt. If it immediately becomes taxable or becomes so upon resale in the secondary market (don't let doctrines like ex post facto lead you to think it won't happen) the price of such bonds will drop dramatically to reflect the higher, taxable yield. On the other hand, if outstanding tax-exempts were to remain so, the price of these bonds would rise appreciably to reflect their newly created scarcity value.

As of now, however, tax-exempt bonds are hardly scarce. New issues of state and local debt have been averaging over $20 billion annually in recent years. Nearly $200 billion of such debt is currently outstanding with approximately half of the total owned by commercial banks and about 25 percent owned by individuals. Because of the importance of banks in the municipal bond market they can provide a useful input in terms of the timing of buy and sell decisions. When money is relatively tight and business loan demand is high banks will tend to liquidate their investment holdings to accommodate corporate borrowers. As a rule of thumb, the latter stages of this cycle proves to be a relatively good time to buy municipal bonds, as prices are depressed and yields high. As business expansion slows, so does demand for bank credit and banks come back to the municipal market with their excess funds, thus (in theory) driving the price of tax-exempts higher.

The two major forms of municipal debt are general obligation bonds and revenue bonds. General obligation (or G.O.) bonds are called so because they are backed by the total taxing power of the municipal authority. They are generally considered to be better credit risks than revenue bonds which depend on the income generated from the project that was financed by the bond issue to pay interest and principal. In the East and Midwest many state highway systems have been financed by revenue bonds with the bond being secured by revenue from highway toll charges. More recently, huge amounts of capital have been raised for pollution control by municipalities issuing revenue bonds.

We shall make the point later that corporate bonds can offer unusual opportunity when their prices are unduly depressed due to economic events. So, too (but to a lesser extent), can the selective municipal bond purchaser take advantage of transitory developments to maximize his yield. If, for instance, one had decided to commit some capital to municipal bonds early in 1974 the most significant distortion (and, hence, opportunity) in the market was the relatively high yield of highway revenue bonds due to concern of investors over the gasoline shortage. The yield advantage of toll revenue bonds over G.O.'s in early 1973 was only 20 basis points (100 basis points = one percentage point) and had widened to 70 basis points a year later. Since these yields are for bonds with 30 to 40 year maturities, the transitory energy crisis provided the long term municipal bond investor with a relatively good buying opportunity. Chart IV demonstrates this yield relationship.

The appropriate strategy to employ when investing in the municipal bond market is one of buy and hold. The secondary market for tax-exempts is simply too thin (i.e., illiquid) to provide an opportunity for profitable portfolio shifts. Unlike the market for corporate bonds, the municipal market absorbs secondary sales only grudgingly and often at as much as 200 basis points higher yield (meaning at sharply lower prices) than one would receive if similar bonds were being purchased. This is, of course, especially true for individual investors as opposed to banks and insurance companies which can command more reasonable prices with their multimillion dollar blocks. Thus, if you buy a tax-exempt bond with the intention of selling at some point down the road, be prepared to part with the bond at a substantial discount from its "true" market value.

What about the tax-exempt bond mutual funds one hears so much about lately? Can't they increase the total return to the investor by astute management of large blocks of bonds? In a word: No. Many people buy these funds thinking that they are receiving "professional management" by doing so. Nothing could be further from the truth. The secondary market for tax-exempts is too inefficient to allow for portfolio management, even for large blocks. The only advantage of a tax-exempt bond fund is diversification. Unfortunately even this feature is negated by the undue risk that virtually all such funds assume.

Tax-exempt bond funds are sold on a front-end load basis. That is, the investor pays a sales charge of anywhere from 3½ percent to 4½ percent of his capital to the underwriters of the fund. Since many potential purchasers of this type of fund are aware of the general level of municipal bond interest rates the sponsors of the fund tend to buy the highest yielding tax-exempts available in order to show a net yield (after sales commission) that approximates the yield on well-known, high quality municipal bonds. In order to accomplish this the sponsors generally put together a portfolio of very low quality debt. A recent study by BARRON'S [6] noted that the largest marketer of tax-exempt funds has been Merrill Lynch, Pierce, Fenner & Smith, which, in association with Bache & Co. and the now defunct duPont Walston Inc., has sold over $1 billion of a series called the Municipal Investment Trust Fund. This fund invests heavily in revenue bonds including such low-grade paper as hospital and urban development revenue debt. The chances of default on a number of the bonds held in a typical M.I.T.F. greatly outweigh the relatively low yield advantage they offer over better grade paper.

The second largest issuer of tax-exempt funds is John Nuveen & Co. Inc. The Nuveen Tax-Exempt Bond Fund series is approaching $900 million. This series is perhaps even more guilty than M.I.T.F. of "reaching for yield" at the expense of safety. A check of Fund 53 of this series reveals a portfolio consisting of such nifty debt as the Township of Middletown, New Jersey, Sewer Revenue Bonds; the City of Farmington, New Mexico, Pollution Control Revenue Bonds; and the Tulsa Industrial Hospital Revenue Bonds. While both Nuveen and Merrill Lynch claim to make a secondary market in their funds, any substantial net sales would cause both firms to mark down the net asset value of the portfolios dramatically. If the secondary market for municipal bonds in general is bad, the secondary market for the types of bonds held in these funds is practically nonexistent.

Incidentally, for you conflict-of-interest fans, most sponsors of tax-exempt bond mutual funds underwrite a significant portion of the bonds that they purchase for their funds. Coincidentally, many of the smaller, hard to market issues that they underwrite are the ones that find their way into the mutual funds.

Having berated the tax-exempt funds for ignoring quality standards, we will now argue that a buy and hold strategy (which we believe is the only appropriate one for municipal bonds) should emphasize the lowest quality bonds that the investor considers "money good" (chances of default on interest payments are negligible). This is essentially a subjective judgment and the rationale is: Why buy an AAA-rated bond that yields less than an AA- or A-rated bond if you are confident that the lower rated securities are money good? An individual may even decide to assume the same level of risk that the bond funds do (although we would advise against it) but there is no reason why he should also pay a 4 percent sales charge for the privilege.

After a little research into quality standards and the relative attraction of G.O.'s versus revenue bonds the next step for the potential municipal bond buyer is to get a list of upcoming new issues from a broker. To repeat, it is not wise to buy in the secondary market unless you have a good knowledge of bond prices. To determine if the new issue you are interested in has been fairly priced consult THE BLUE LIST, a publication of municipal bond offerings (available in any brokerage office) that should give you a reasonable idea of where the market is that day. The appropriate tax-exempt bond can then be purchased at virtually the same price that the bond funds would pay for it.

One last note on municipal bonds. Because the discount from par value is treated as a taxable capital gain, municipal bonds with low coupons selling below par yield more than comparable current coupon bonds selling at par. This is just the reverse of the case with taxable bonds and is due to the fact that part of the total return of the discount municipal bond is taxable. Thus, it must yield more to provide an after-tax yield similar to the current coupon tax-exempt. Municipal bonds are bearer (as opposed to registered) bonds and many an unscrupulous individual has been able to increase his tax-free return by buying discount municipal bonds and not reporting the cost to the IRS when the bond matures. As an example, in March of this year The Blue List quoted a top quality Los Angeles G.O. with a 4.40 percent coupon, maturing in 1981 at a yield to maturity of 4.10 percent and a discount bond of the same municipality with a coupon of 2.50 percent also maturing in 1981 at a yield to maturity of 6.00 percent. The lower the coupon, the greater the yield before taxes for municipal bonds.

BOND PORTFOLIO MANAGEMENT

The second of the three basic methods through which we believe an individual investor may intelligently participate in the long term bond market is taxable bond mutual funds. The corporate and federal government bond markets are many times more efficient than the municipal bond market, thus allowing a bond portfolio manager to shift capital from one sector of the market to other sectors without incurring prohibitive transaction costs. The main thesis behind buying corporate bond funds is that a total return significantly greater than that provided by interest payments alone can be achieved by selectively purchasing relatively undervalued bonds and subsequently selling them at a profit. This, then, adds a capital gain to the income return. Chart V shows the total return for the Solomon Brothers High Grade Long-Term Bond Index relative to the coupon return alone.

Just how much can the investment return be improved and how is it accomplished? These questions must be answered before a corporate bond fund can be purchased on anything other than blind faith. Let us, then, briefly discuss the theory of bond portfolio management.

The implementation of a bond management program is predicated on the fact that there always have been and will continue to be significant shifts in relative values within the bond market. Some bonds will always possess more opportunity for favorable price performance than others at any given point in time. The portfolio manager should view bonds as dynamic, rather than static, investment vehicles that possess opportunity for capital growth as well as income. As Chart VI points out, individual bonds often behave in very dissimilar manners.

This "total return" approach to bond management involves three basic levels of investment strategy. The first level, and the one of greatest importance to the total performance of the portfolio, is that of structuring the weighted average maturity profile of the fund to reflect a projection of future interest rate levels. In general, when the projection is for higher interest rates capital should be shifted to shorter maturity bonds or cash to avoid the expected decline in long term bond prices. Conversely, long term bonds should be emphasized when the projection is for lower interest rates. Many bond funds realized substantial profits in the rally in bond prices in late 1970, for instance, when rates declined sharply from levels approaching 10 percent. As discussed previously, a close scrutiny of Federal Reserve policy can be most helpful in projecting long term interest rates.

Having established an appropriate maturity profile for the portfolio, one then proceeds to invest (within those maturity parameters) funds in the most attractive sectors of the market. Sector analysis, as the second level of bond management strategy, concerns itself with three main factors in bond valuation: coupon, issuer and quality. Each of these factors represents a distinct sector within the overall bond market. The constantly changing interrelationships of these sectors present substantial opportunity to the skilled portfolio manager.

Probably the most important of the sectors is the bond coupon. The relative values of discount, current coupon and premium bonds depends both upon their present price relationships and the future direction of interest rates. A fact of which few investors are aware is that coupon payments on an 8 percent, 30 year bond priced to yield 8 percent (i.e., at par) account for only 25 percent of the total dollar return over the life of the bond. The other 75 percent consists of the return derived from reinvested coupon payments. Thus, in general, the higher the assumed reinvestment rate (read: the more inflation one anticipates), the less attractive discount bonds are. This is because less of the yield from discounts is comprised of coupon payments, thus reducing the amount of money that can be reinvested at higher interest levels. Interestingly, if one assumes no reinvestment of coupon income, deep discount bonds almost invariably provide a greater total dollar return to maturity than do current coupon bonds.

The next sector in terms of importance is that of the issuing entity (e.g., governments, railroads, industrials, utilities). Relative values within this sector tend to be based on the supply of bonds available from a given type of issuer as well as the economic factors affecting the specific industry involved. Different issuers often have different terms associated with their debt. For instance, the call protection on utility and industrial bonds is 5 to 10 years, respectively, while railroad equipment trust certificates are noncallable.

The third basic sector subject to analysis is that of bond quality as represented by the ability of the borrowing entities to promptly pay interest and principal when they are due. United States Government obligations are generally considered to have the highest quality and, therefore, yield the least because the investor doesn't face the possibility of default (or so they tell us). As the quality of bonds lessens the yield or interest rate the issuing entity must pay to its lenders increases.

Using historical data it is possible to determine an appropriate or normal yield spread between differing qualities of bonds. When these spreads get out of line, appropriate action on the part of the bond fund portfolio manager should be taken. Since 1968 the spread in basis points between high and low rated bonds has ranged from as little as 35 basis points to as great as 280. Clearly, opportunity exists here to improve the overall return of the fund. Generally, quality spreads narrow during an economic boom and widen during a recession. It would follow, then, that high quality bonds should be purchased when the economy is strong since very little extra income can be gained by investing in lower quality, higher risk bonds.

The final, and least important, level of bond management strategy is that of arbitrage. Most investors view bond management as consisting almost entirely of arbitrage or "like-for-like" swaps where yield differentials in similar bonds are taken advantage of. Such is not the case. Real arbitrage opportunities are very scarce and offer far less opportunity than does a program of structuring the bond fund's portfolio in a manner consistent with interest rate projections and sector analysis.

THE BOND FUNDS

The theory of bond management may sound good, but does it work? If done intelligently the answer is yes. We know of one major investment counseling firm managing over $400 million in discretionary bond funds that have shown a compounded annual rate of return of 12.5 percent from the middle of 1970 through 1973. This is 25 percent better than the figures for Salomon Brothers High Grade Long-Term Bond Index which show 10.0 percent compounded for the same time period. So it can be done. The question one is faced with is which bond fund to purchase. How do you tell them apart and what are the relevant considerations?

Of primary importance in judging a bond fund is the experience of the portfolio managers. This is often information that is unavailable in the prospectus of a bond fund but a competent stockbroker should be able to get the information for you. As a rule of thumb, managers with bond experience working for investment counseling firms are more attuned to dynamic bond theory than are bank portfolio managers. Good bond managers are few and far between as evidenced by the fact that a major California bank recently raised over $50 million in offering its new bond fund but was not able to locate a portfolio manager for some two months subsequent to the offering.

Next in importance to the portfolio manager himself is the investment philosophy of the fund. Many bond funds emphasize a high level of current income. Such funds very often concentrate their holdings in high coupon, "premium" bonds (i.e., those selling above par value) and bonds of questionable quality in order to maximize yield. These funds, in addition to assuming more risk than they should, are subject to having much of their portfolio called away from them should interest rates decline. A maximization of current income philosophy may also indicate a low level of investment activity (which is fine for a common stock mutual fund but not for a bond fund).

Maximization of total return (i.e. recognition of capital gain opportunity) is the investment objective that can make taxable bond funds competitive with municipal bonds on an after tax basis. These funds generally have a high level of portfolio turnover (reflecting the dynamic nature of the bond market) and, if intelligently managed, can be quite attractive investment vehicles.

Management fees on bond funds are generally ½ of one percent of the market value of the fund, which ain't cheap but which can be worth it if a competent job is done. Fees over ½ of one percent are extremely hard to justify and are best avoided. A last consideration is the size of the fund. Funds over $100 million in size will have increasing difficulty in maximizing total return as the portfolio simply becomes overloaded with too many and too large holdings.

FIRE SALES

The final area of opportunity for the individual bond investor is that of unreasonably depressed corporate bonds. Probably the classic example of how significant gains can be made through this type of investing was in the summer of 1970 immediately following the Penn Central bankruptcy. Virtually every bond that was issued by a corporation that even sounded as if it might be associated with a railroad dropped precipitously in price. Most rail bonds that were purchased during those bleak days have proven to be rewarding investments. Ironically, one of the best of the group was the Pennsylvania Co. 9% debentures due in 1994. They could have been purchased in 1970 at $48 ($480 per $1000 par value) which was a yield to maturity of 19 percent. At this writing the bonds are selling near par. Less dramatic but nonetheless profitable was the Missouri Pacific Railroad 5% debentures due in 2045 which went from $38 to a recent price of $53.

Examples of this nature abound in industries other than railroads. Both the airline and steel industries were thought to be in serious trouble in 1970 and while a good argument could have been made for avoiding the stocks of companies involved therein, there was never any serious question as to the credit worthiness of a Western Airlines or a Jones & Laughlin Steel. Yet the J & L 6¾% of 1994 could have been purchased for $51 and the Western Airlines 5¼% of 1993 was selling as low as $37. Recent prices were $74 and $100, respectively. The Western Airlines bonds appreciated by some 170 percent.

The secret to buying bargain bonds in a "fire sale" atmosphere is to know the balance sheet of the company involved. If the assets are productive and marketable and the debt is not onerous, significant opportunities can exist in distressed company bonds.

SHORT TERM INVESTMENTS

It is even more difficult for the individual to successfully participate in the short end of the market for fixed-income securities than it is in the long end of the maturity scale. Savings accounts are a rip-off of the first degree. Many banks offer pooled finance paper funds which may be purchased in blocks as small as $5,000. This service is generally available only to trust department customers but it is a reasonable value if available. Treasury bills may be purchased in blocks of $10,000 from most banks although one should be wary of $20 to $30 acquisition costs that can have a significant negative effect on very short (30 and 60 days) bills. Tax-free tax anticipation notes are also available now at quite competitive after-tax yield for very short maturities.

A new alternative for the short term individual investor has recently emerged in the form of the Reserve Fund, Inc. This is a no load, open end mutual fund that invests in a diversified portfolio of certificates of deposit and bankers' acceptances. As of this writing the fund was yielding (after a management fee of 1/2 percent) approximately twice what was available from 1 bank savings account. Money can be deposited or withdrawn from the fund on a daily basis in units as small as $1,000, with interest credited daily. Write to the Reserve Fund, Inc., 1301 Avenue of the Americas, New York, NY 10019, for further information.

SUMMARY

We hope to have demonstrated some of the more rational approaches an individual investor may take toward the bond market. We advise against individuals trying to "swap" bonds on their own. Municipal bonds should be bought with the idea of holding them to maturity and only on a new issue basis unless you have extreme confidence in your broker.

In discussing bond funds we purposely ignored the numerous funds that specialize in U.S. Government securities because they simply yield less than other taxable high quality bonds. With respect to government bonds (federal, state and local) we will end with the comment that many libertarians avoid purchasing bonds that depend on taxing power to pay principal and interest. This is a moral issue with which we are in sympathy. The people responsible for paying interest on corporate debt have taken that responsibility on voluntarily. Those held responsible (at the point of the tax collector's gun) for paying the interest on government debt have no moral obligation to do so.

Edward H. Crane, III has been an institutional portfolio manager for two of the nation's largest investment counseling firms during the past six years. Mr. Crane currently has investment responsibility for over $100 million of pension and endowment capital. A 29 year old bachelor with a B.S. from the University of California, Berkeley and an M.B.A. in Finance from the University of Southern California Graduate School of Business Administration, he lives in San Francisco, and is active in the Libertarian Party.

NOTES & REFERENCES

[1] William E. Gibson, JOURNAL OF POLITICAL ECONOMY, Vol. 78, No. 31, pp. 431-55.
[2] Beryl Wayne Sprinkel, MONEY & MARKETS (Dow Jones Irwin 1971).
[3] Ibid., p. 208.
[4] Care should be taken to buy municipal bonds within one's state of residence since out-of-state bonds are often subject to state income tax.
[5] Gordon L. Calvert, FUNDAMENTALS OF MUNICIPAL BONDS (Investment Bankers Association of America 1968), p. 115.
[6] David Herships, BARRON'S, Feb. 25, 1974, p. 3.

Note: Charts IV, V, and VI are reproduced here courtesy of Salomon Brothers, New York, NY.