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Further info on Equity Accounts || Further info on Balanced Accounts

FIXED INCOME ACCOUNTS

"Capital is to a money manager as plant and equipment
to a manufacturer. If there's a fire at the factory,
you want to have something set aside in order to rebuild."

Every portfolio should, in my opinion, have two components: a risk allocation, and a certain amount of "safe money."

For the portion of your account that must remain secure, or for the investor seeking steady cash flow from his or her assets, and a minimum of exposure to the vagaries of the market, we offer a managed bond account.

These Fixed Income accounts contain primarily investment-grade bonds of varying maturities. Often, depending upon the client's risk tolerance, a portion of the account is directed to convertible bonds and preferred stocks, in order to provide some possibility of capital gain.

Bonds are selected based upon credit quality, maturity, call provisions, and relative value given the conditions prevailing in the market. Historically we have "laddered" maturities, that is, we arrange the portfolio so that bonds are maturing or being called on a regular basis. This eliminates the necessity of making a guess as to the direction of rates. (Of late, though, we have the strong opinion that rates should go up over the next few years. This has changed our approach. See below for further discussion.)

As mentioned, depending upon the individual client, we can add convertible bonds and preferred stocks to the mix. A small allocation of below-investment-grade securities can also be utilized to increase returns. The decision to include these types of securities is made in conference between you, the client, and James Pappas as the manager.

We have lately emphasized bonds of less than three years maturity, due to our sense that rates should rise over the next few years (see note below). In buying these bonds we attempt to better the money-market yield by 100 basis points. Here are but a few examples of bonds that we purchased late 2007-early 2008:

     Electronic Data Systems 7.125s'09 at 101.1, yield to maturity 6.16% (BBB-)
     LaSalle Funding 4.5s'10 at 98.6, yield to maturity 5.9% (AA-)
     N.Y. Times 4.5s'10 at 96, yield to maturity 6.08% (BBB)
     Temple-Inland 6.75s'09 at 101.85, yield to maturity 5.69% (BBB-)
     Thiokol 6.625s'08 at 100.42, yield to maturity 5.33 (BBB+)
     Union Carbide 6.7s'09 at 101.25, yield to maturity 5.72% (A-)

We have generally not been buyers of longer-dated bonds for the last 12-24 months, preferring instead to allow cash balances to grow (via calls and maturities), and to reinvest that money in shorter paper, as mentioned above, in anticipation of lower prices in the face of rising rates. The current strategy is one of protection of principal.

Even in the convertible-bond arena there is scarce availability of attractive issues. However, here are some examples of bonds that we continue to own:

Convertibles:
    Amazon.com 4.75s'09 at 123, callable, convertible to 12.816 shares AMZN
    IVAX 4.5s'08 at 103, matures May 15, 2008, convertible to 13+ shares of TEVA plus approx. $400 cash
    Electronic Data Systems 3.87s'23 at 99, convertible to 29.2912 shares EDS, puttable at 100 in 2010

(See below for an explanation of the bond listings.)

Note: Currently, bond prices are very high, yields very low, and the fixed-income markets in general appear vulnerable. I have thus made an effort to shorten maturities, including likely call candidates. During the last 12-18 months I have been reticent to make bond purchases in general, although recently I am seeing a handful of shorter-maturity offerings that are attractive. I continue to stress investment-grade issues as the basis of a fixed-income portfolio, but at this point in time, caution is advised. Due to the paucity of new buys, I have included above a few convertible issues that appeal to me. The convertibles are all below investment-grade. None of the above is to be construed as a recommendation.

While I often buy bonds that I believe will be called, you must know that there is no guarantee that any given bond will be called. You should further know that bonds are readily salable, but that the price available will be dependent upon market conditions, and may well be lower than your cost.

It is my style to be a buyer of bonds and never a seller. That is, I buy and hold until call or maturity.

The goal is to produce steady cash flow, while avoiding exposure to the fluctuations of the stock market. It is important, however, to remember that, as mentioned above, bonds do indeed fluctuate, sometimes dramatically. While this means that your monthly statement may reflect an increase or decrease in principal, it is equally important to know that, with bonds, at a certain point in the future you will receive at least par value for your holdings. I suggest to bond buyers that they ignore fluctuations in market value and instead concentrate on the yield of their holdings.

EXPLANATION OF BOND LISTINGS

Here is how to read these bond descriptions, using this example from December 1999 (those were the days!):

BellSouth Telecom 7 7/8s'32 at 98 1/2 callable Aug. '02 at 104.29 (AA-)

>The name of the issuer is, of course, BellSouth Telecom
>7 7/8 is the coupon (expressed as a percent)--multiply par value ($1000) by this percentage to find your annual income per bond, here $78.75
>s'32 indicates that the bond matures in the year 2032 (the "s" separates the coupon from the year of maturity)
>98 1/2 is the bond's price, expressed as a percentage of $1000--in this example $985 per bond
>callable Aug. '02 at 104.29 means that on August 1, 2002, the company has the option of paying you $1042.90 per bond to retire the issue
>(AA-) is the Standard & Poor's rating, with AAA being the highest and BBB- being the lowest investment-grade ratings. Ratings of BB+ and lower are called "junk bonds".

In this example, you would receive your coupon interest of $78.75 per annum for each bond held, which equates to a current (annual) yield, based upon a cost of $985 per bond, of slightly more than 7.99%. (Divide $78.75 income by $985 cost to arrive at this figure.) Should the company "call" the bond in August of 2002, they would pay you $1042.90 per bond, resulting in a capital gain of $57.90 per bond. The happy result is that you reap an additional 5.88% on your invested capital. Divide that premium by your holding period and add the result to your current yield to arrive at an approximate "total return".

NOTE:

There are several calculations of yield, including current yield, yield to maturity, yield to call and yield to worst. Other factors to be considered include sinking fund provisions, holders redemption options, fixed charge coverage, credit watch direction. Please educate yourself before buying any security.

IMPORTANT:

James Pappas and James Pappas Investment Counsel LLC makes no recommendation as to the suitability of these securities for your account. You should not infer that a listing above implies a recommendation of any kind. The securities listed are shown for purposes of illustration only.

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