I purchased some preferred stocks over the past year, and with the rise in interest rates they have all fallen, unexpectedly but sadly, a point or two. Do you think they will fall significantly further if Greenspan raises interest rates 50 basis points? -- Stu Daling


I regret I didn't get a chance to answer you sooner. You wrote on Aug. 13 (before the


25-basis-point hike in the fed-funds rate to 5.25% on Aug. 24), at what turned out to be the bottom of a pretty rough period for all kinds of corporate debt instruments. I don't know which preferred shares you have, and there's no index for the group, but a look at a few representative issues shows that they have rebounded nicely.

Preferred shares, for readers unfamiliar with them, are a hybrid security, with characteristics of both stocks and bonds.

As stocks, they are exchange-listed and -traded, so there is much greater price transparency and liquidity in them than in corporate bonds. But like bonds, they have a face value (typically $25), a fixed payment rate (the payment is called a dividend rather than a coupon, and payments are typically made quarterly or monthly rather than semiannually), and a maturity date (typically 30 to 40 years, though most are callable in five years).

Preferred stockholders don't have voting rights, but companies can't pay common dividends until they've paid preferred dividends. At the same time, preferred shares have a weaker claim on the issuer's assets than bonds do, so they typically carry a slightly lower rating than a company's bonds. Most issuers reserve the right to defer dividend payments on preferreds in times of stress.

As hybrids, preferreds respond both to changes in issuer fortunes and to changes in interest rates. As is true in the corporate bond market, the better the quality of an issue (the higher its rating), the more it trades like a bond, rather than a stock. That means it will be more responsive to changes in interest rates than to changes in the company's near-term prospects. Most preferreds are issued by either financial companies or utilities.

In any case, investment-grade preferreds rarely trade outside a range defined by 22 on the downside and 26 1/2 on the upside for an issue with the typical face value of $25. The upside potential is capped by the call: When interest rates fall, issuers become more likely to exercise their call, which makes investors unwilling to pay much more than face value for them.

When you wrote, many preferreds were trading at the low end of that range. Their prices tumbled along with those of corporate bonds, in part because of fear of the Fed, but in larger part because of a perception that more corporations were lined up to issue new debt than there were investors wishing to buy it. That concern has moderated somewhat in recent weeks, and as you can see from these charts for a few representative preferreds, share prices have recovered.

Duke Capital Finance, 7 3/8%

ABN AMRO Capital, 7 1/2%

International Paper Capital, 7 5/8%

Bonds vs. Bond Funds

"How much money does one need to economically buy individual bonds instead of bond fund shares?" is one of those questions that can give rise to a slugfest. Some fund managers insist that one shouldn't buy less than $1 million of a single issue in order to avoid paying outrageously large markups to bond brokers, a sum that makes diversification extremely expensive. Bond brokers fire back that it's almost always more economical to pay the one-time markup than it is to submit to the outrageously high expense ratios some bond funds charge year after year. Before you know it, someone's got a bloody nose.

To some degree, the decision between bonds and bond funds depends on things that are investor specific. How much diversification do you want? Is one bond OK if it's got a decent rating, or do you want at least five? If you're going to buy from a broker, as most folks still do (online bond trading has yet to catch on in a big way with individual investors), do you trust him to get you good bonds at a fair price, or do you feel like you're at his mercy?

But in a study released last month,

Charles Schwab's Center for Investment Research

drew the guideline at $50,000. An investor with at least $50,000 to invest in fixed-income products may be better off in bonds, while one with less may be better off in bond funds.

It arrived at that number by comparing the annual cost of maintaining a five-bond ladder ($10,000 each in five bonds maturing in tow, four, six, eight and 10 years) with the annual cost of investing in the lowest-expense bond fund. For reference, it also looked at the annual cost of investing in an average-expense bond fund.

The cost of maintaining the ladder represents the premium the small investor pays for buying small lots. When fund managers buy bonds for their funds, they buy larger lots and get the bonds at a lower unit price, which gets passed along to their shareholders.

Schwab calculated that with $50,000, the cost of maintaining a ladder is slightly lower than the cost of investing in the lowest-cost bond fund, except for municipal bonds, where it is just slightly higher. But for all types of bonds, you can maintain a $50,000 ladder for less than an average-expense bond fund will cost. Here is a summary of the findings:

The study can be obtained by calling Schwab at (800) 435-4000.

Cool, New Closed-End Fund Info


Closed-End Fund Association

, which launched a good, free

Web site in March, made it much better a couple of weeks ago with the addition of a feature that shows the leading funds by premium, discount, and year-to-date market and NAV returns. You can narrow a search to a particular asset, fund family, expense ratio or some combination of the three. Click on "Custom Search."

Send your questions and comments, along with your full name, to

fixed-incomeforum@thestreet.com. Fixed-Income Forum appears each Friday.

TSC Fixed-Income Forum aims to provide general bond information. Under no circumstances does the information in this column represent a recommendation to buy or sell bonds, funds or other securities.