Investing in Bonds

Jerry Jevic Senior Director – Investments

Oppenheimer & Co. Inc. 1818 Market Street Philadelphia, PA 19103 (800) 247-3243 (215) 656-2866 [email protected] http://fa.opco.com/jerryjevic/

CONTENTS Page

Why Invest in Bonds ...... 1

Corporate Bonds ...... 2

High Yield Bonds...... 3

Convertible Securities...... 6

Third Party Trust Preferred Securities ...... 9

Municipal Bonds ...... 10

Pre-Refunded Bonds (Liquid, Advantaged) ...... 13

Conclusion: An Essential Asset Class ...... 14

Definitions ...... 15

About Oppenheimer ...... 17 WHY INVEST IN BONDS?

Because high-quality bonds such as government securities and investment-grade corporate bonds have tended to preserve capital even in economic downturns, they have traditionally been used to help hedge portfolios against volatility. Their low correlations with stocks serve to help control risk.

Prudent investors should understand the risks and rewards of different types of bonds so they can select the types, with the guidance of their Financial Advisor that meet their needs for income, fall within their risk tolerance and have the potential to help achieve their financial goals.

Bonds represent contracts between a government or corporate issuer and the investor (or creditor). Creditor status gives an investor rights to repayment when a matures (and to pay back principal) and to interest during the bond’s life unless the issuer redeems, or calls it.

When a bond is issued, its interest, or rate, is fixed for the life of the bond. Bonds are usually issued at a value of $1,000 on the primary market. This is called “par value” and also referred to as the principal or face value. Bond maturities may range from a few months to as long as 100 years (century bonds). In general, longer-term bonds pay a higher rate of interest than short-term because investors require a premium if they are to lock up their money. In addition, they want to be compensated because longer-term bond prices tend to be more volatile due to fluctuations in the secondary markets and the overall economy during their duration.

Although stock dividends may rise or fall, depending on a company’s performance, bonds provide a steady income stream as defined in the bond indenture – the basic document that defines the bond’s terms. Usually, bonds pay interest at six-month intervals based off their maturity date. For example, a bond issued in January would pay interest every July and January until it was called or it matured.

This publication is a guide to the for thoughtful investors. In addition to the high-quality government and corporate securities mentioned here, it will also deal with some of the other types of bonds investors are likely to encounter if they and their advisors seek to build a diversified bond portfolio. Among the other types of securities touched on here will be high yield (below investment grade) bonds, convertible securities, third party trust preferred securities, municipal bonds and pre-refunded bonds. A glossary is also provided.

1 CORPORATE BONDS

Corporate bonds are issued by companies seeking to raise funds. A legal document or security contract (the indenture) defines the terms of the bond and the duties or responsibilities of all related parties. The interest, or coupon, for corporate bonds is stated in the indenture. Except for variable rate bonds, this interest rate does not change. Corporate bonds may be unsecured or secured. Unsecured bonds are backed by the full faith and credit of the issuer, while secured bonds are backed by collateral such as mortgages or equipment.

Example: XYZ Corporation issues a 5% bond, due 5/15/2010, in multiples of $1,000. The rate of interest is 5%, or $50 per year for the life, or duration, of the bond. Interest is paid semi-annually on 5/15 and 11/15 in amounts of $25.00 per bond. Interest is paid until 5/15/2010 when the bond matures and the debt is repaid.

• Call Feature. Usually, corporate bonds possess a call feature enabling a corporation to redeem them after a pre-set interval, often five years. Bonds are called when the issuer has calculated that redeeming them, even at a premium, is cheaper than continuing to pay interest. Thereafter, bonds may be called at any time until maturity even during a month when interest is not due. Because calling a bond deprives investors of an income stream, the investors must be compensated if they are to buy the bonds. Therefore, if the bonds are called at a time when the bondholder still has considerable interest to receive, the bond will be called at a premium to make up for the lost interest). As the bond approaches maturity (and less interest remains to be paid), its call price will drop toward par. Call schedules indicate what investors will receive as of various pay dates. They are contained in the indenture. • Secondary Market Trading. Bonds are traded day to day on the secondary market, as opposed to when they are issued. This means the price you pay for a bond on the secondary market can vary due to factors such as one bond’s interest rate compared with another; time to maturity; the issuer’s credit quality; the existence of a call feature as well as company news and general economic conditions. Bonds can be sold for more or less than the par value of the bond. • Credit Quality. Bonds come in a variety of credit qualities, as assigned by rating agencies such as Moody’s Investors Service, Standard & Poor’s Ratings Service or Fitch Ratings. These ratings range from investment grade to defaulted bonds. Some bonds carry higher ratings than might be expected because they are guaranteed by another corporation, such as a parent company, to pay interest and principal and thus protect against default. (Please see the chart on page 7.) You should review with your Financial Advisor what these ratings mean and how they correlate to your risk tolerance. • Liquidation Schedule. Corporate bonds are referred to as senior securities, because the corporation must pay bond interest before it pays dividends to stockholders. If the company goes bankrupt, bondholders and other creditors are repaid before equity owners.

Who Gets Paid First? 1. Employee Wages 2. 3. Secured Creditors (including Secured Bonds) 4. General Creditors (including aka Unsecured Bonds) 5. Subordinated Creditors, including Subordinated Debentures 6. Preferred Stockholders 7. Common Stockholders

2 HIGH YIELD BONDS

Until the 1970s, the high yield market was relatively small, consisting primarily of bonds issued by companies whose credit quality had declined below investment grade according to the rating agencies. Most investment portfolios tended to avoid high yield debt, and most dealers did not carry it. Today, however, the market for high yield debt has burgeoned. A report from Moody’s (quoted on April 15, 2009 by Bloomberg) claims that high yield issuers have about $25.7 billion of bonds and loans coming due in 2009, $44.3 billion in 2010 and $119.6 billion in 2011.

As the high yield market has grown, it has attracted increasing numbers of investors. Institutional investors such as insurance companies and pension funds are increasingly altering their investment guidelines to purchase high yield debt, either for its higher rate of return or as an alternative to purchasing equities. Individual investors whose capital and risk tolerance enable them to do so purchase high yield bonds as part of their allocation to assets.

Definition of High Yield Bonds High yield bonds are issued by organizations that do not qualify for investment-grade ratings from the major bond rating agencies. In evaluating high yield debt, rating agencies study corporate financial data. They meet with issuers’ management, set the proposed issuance in its economic and industrial context and scrutinize the bond indenture for special provisions that may create additional credit risk.

Issuers of high yield bonds can include corporations, certain U.S. banks, various foreign governments and some foreign corporations. In general, high yield bonds tend to be issued in various amounts. The maturities of a high yield bond, like other types of debt, are determined by the issuer to suit their capital needs. Shorter bonds are often called notes, or short term debt.

The interest from high yield bonds (but not high yield municipal bonds) is subject to federal and state income tax, and taxed as ordinary income. Investors who have questions about the tax treatment of high yield (or indeed any other bonds) should consult their tax professionals.

Risks Because high yield bonds have a higher risk of default, if the issuer’s credit rating is downgraded, interest rates rise or if financial, corporate or economic news make investors become more conservative, the price of the securities may have a downward bias in the secondary market. If such markets persist, corporations may find it difficult to issue new debt. This situation can put pressure on the prices of existing high yield bonds.

Potential Advantages of High Yield Bonds Because high yield bonds possess greater risks, they must pay a higher interest rate to attract buyers. If the bond issue’s financial condition improves and its credit rating is upgraded, the investor may benefit from capital appreciation as the bond prices rise on the secondary market, but there is no guarantee that this might happen.

High Yield Issuers • “Rising stars,” or start-ups that have not yet developed the institutional history, strength or capital to earn an investment grade rating. • “Fallen angels” or companies that formerly held investment grade ratings. • Companies with high debt loads may issue speculative grade debt to pay down bank lines of credit, retire other bonds, consolidate previous , or to fund acquisitions, buyouts or defend against a hostile takeover.

3 HIGH YIELD BONDS (continued)

• Leveraged buyouts use high yield debt to take a public company private. • Capital-intensive companies unable to finance all their capital needs through earnings or bank loans may issue high yield debt.

High Yield Bond Varieties • Straight cash bonds – Bonds that offer a fixed coupon, paying in cash, as opposed to stock, as in the case of convertibles, usually on a semiannual basis, until the call date or maturity. • Split coupons offer one interest rate in the early years of the bond’s life, followed by a second rate later on. If interest rates increase later, those bonds are called step-up notes. • Pay-in-kind bonds mean issuers may receive interest in cash or securities. • Floating-rate and increasing-rate notes (IRNs) pay fluctuating rates of interest as pre-set upon issuance. • Zero coupon bonds do not pay semiannual interest. Investors who anticipate a future need for capital purchase zero coupons at a substantial discount to face, or par value of $1,000. When the bonds mature, their owners redeem them at $1,000 and thus realize the sum they need. Because zero coupons can be volatile, the investor who sells them before they mature runs the risk of a substantial loss of principal.

Bond Credit Ratings by Major Agencies

Credit Risk Moody’s Standard & Poor’s** Fitch Ratings** Investment Grade Highest Quality Aaa AAA AAA High Quality AA AA AA Upper Medium Grade A A A Medium Grade Baa BBB BBB BELOW INVESTMENT BELOW INVESTMENT BELOW INVESTMENT BELOW INVESTMENT GRADE GRADE GRADE GRADE Not Investment Grade Ba BB BB Lower Medium B B B Investment Grade Low Grade Caa CCC CCC Poor Quality (may default) Ca CC CC Most Speculative C D C No interest paid or C D C bankruptcy petition filed In Default C D D

Sources: Securities Industry and Financial Markets Association (SIFMA) www.investinginbonds.com and Oppenheimer & Co. Inc. *Moody’s ratings from Aa to Ca may be modified by adding a 1, 2 or 3 to show relative standing of each issuer within a given rating category. In addition, Moody’s may express a bond outlook to indicate in which direction it believes the bonds will move. **Standard & Poor’s and Fitch’s ratings may be modified by the addition of a plus or minus sign to show relative standing within a given rating category.

4 HIGH YIELD BONDS (continued)

How Bonds Pay Out Even though bonds mature at $1,000, they may trade throughout their lives at various prices on the secondary market. Bonds that trade below par ($1,000) are called discount bonds, while bonds that trade above par are called premium bonds.

Current yield is the bondholder’s annual rate of return on investment. It can be calculated by dividing the annual income by the cost of the bond.

Example: Annual income = 7% X $1,000 ($70 per year when trading at par) Actual Bond price = $900 (or $100 below par of $1,000) Annual Income $70 = = 7.77% per Year Cost of Bond $900

The (YTM) is a combination of the current yield and the difference between the price paid for a bond versus its value at maturity ($1,000). Investors holding the bonds until maturity receive the YTM.

A purchase of a $1,000 bond, with a 7% coupon due 6/15/2010 at $900 per bond versus the same bond purchased at $1,100 per bond

BOUGHT AT $900 Current Yield = 7.77% Yield to Maturity = 8.46%

BOUGHT AT $1,100 Current Yield = 6.36% Yield to Maturity = 5.71%

Note that the yield to maturity (8.46%) exceeds current yield (7.77%) when a bond is purchased at a discount to par. This is because, at the bond’s maturity, the investor would have received more money than was initially invested. By contrast, a bond selling at a premium to its $1,000 par value has a lower YTM (5.71%) because the investor receives less money at maturity than the original investment.

5 CONVERTIBLE SECURITIES

In financial markets where stocks are underperforming and bonds also are weak, investors who desire to combine capital appreciation with protection of their investment principal might well consider convertible securities. These bonds differ in several ways from conventional bonds. In general, convertibles do not provide a high rate of interest. The feature that makes them most attractive to investors is the ability to convert them into common stock at some later date. Conversely, if the issuer writes a forced conversion clause into the indenture, the investor may have no choice but to convert – a point that may make the bonds less attractive.

It may be helpful to think of convertible securities – both bonds and stocks – as vehicles that may provide investors with the benefits of both asset classes. Investors with large allocations to bonds have the possibility of a conversion to stock as a way of hedging against inflation. Stock-heavy investors gain some limited income along with the reduction of volatility provided by bonds.

Like ordinary bonds, convertible bonds are issued with a set semi-annual interest rate and a call feature. The distinctive feature of the is that its owner is able to convert the bond into the issuer’s common stock. In other words, the creditor can become an owner and benefit if the issuer’s common stock appreciates. How many shares the bond owner will receive when converting the bond into common stock is indicated by the conversion ratio, which is established when the bond is first issued and contained in the bond’s indenture.

Convertible preferred stock, often referred to as “convertible preferreds,” is a form of equity ownership. It consists of nonvoting shares that can be converted to voting shares, or regular equity ownership.

The payments on all preferreds, including convertible preferreds, take the form of dividends, rather than interest, and are paid quarterly rather than semi-annually. One critical difference: if a bond fails to pay interest on time, it would be considered an element of default and could, accordingly, put the company into liquidation. By contrast, the omission of a preferred dividend is not an indication of default. Nevertheless, if a dividend is skipped in one quarter, at some point, all dividends must be paid if the indenture contains the provision that dividends are cumulative.

Because preferred stock securities represent equity ownership, they are considered junior to all debt issues, including convertible bonds.

Features of Convertible Bonds Consider the convertible bond described below: 1. Cost per Bond = $900 (a $100 discount) 2. Coupon Rate – 7% or $70 per year 3. Interest Rate Paid Semi-Annually = $35 per payment 4. Current Yield = 7.77% (greater than interest rate because bond sells at discount) 5. Maturity Date = 5/15/2017 6. Call Date = 5/15/2012 7. Call Price = $1,050 per bond (bond sells at premium) 8. Underlying Common Stock Price = $14.50

6 CONVERTIBLE SECURITIES (continued)

Although the bond’s maturity date is 5/15/2017, the company reserves the right to pay $1,050 on or after the bond’s call date of 5/15/2012. Each convertible bond holder (or, for that matter, each holder of preferred stock) has the right to exchange his or her security for a fixed amount of common stock of the issuing company. The value of the convertible bond will be influenced by the price and the volatility of the company’s common stock.

Example: Bond Cost = $900 Conversion Ratio = 50 shares Stock Price = $14.50

Conversion Value = (50 shares X $14.50 = $725 Premium per Bond = ($900 - $725) = $175 Premium Percentage = ($175 / $725) = 24.14%

Therefore, the conversion premium per bond represents the difference between the cost of the bond and the amount received if:

1. the bond was converted into common stock 2. the stock was then sold at $14.50 per share.

Assume that the common stock rises in price to $24 per share. In that case, the conversion value would be $1,200 (50 shares multiplied by $24 per share). The price of the bond would also appreciate to reflect the increase in the price of the company’s common stock. The bond would then trade at a premium, around $1,200 per bond, for a capital gain of $300 (above par) per bond.

If the bond did not appreciate in value as the common stock rose, an alert bond trader could buy it at a discount to conversion value, submit it to the issuer, receive 50 shares of stock and then sell the stock at $24 per share for a total gain of $1,200.

An investor who purchases a convertible security has two advantages over the holders of an equity security (i.e., common stock):

1. Safety of principal (when the bond matures, assuming it does not default, it will mature at $1,000 or par, just as it was issued) 2. Relative income stability at the interest rate set in the indenture

If the issuer’s common stock rises in price, the convertible will also rise in price to reflect the increased value of the underlying common stock. In that case, the investor can realize this upside potential by selling the convertible bond on the secondary market, yet not convert it into its issuer’s common stock. If the price of the underlying common stock declines, the convertible can be expected to decline only to the point at which it yields a satisfactory return on its value. Unlike a call, which occurs only at intervals specified by the indenture, convertible securities may be converted at any time.

7 CONVERTIBLE SECURITIES (continued)

Momentum and Call Features An important part of investing is staying with an upward trend. The investor whose cash flow and risk tolerance makes him or her capable of riding the price upward (and knowing when to sell) can indeed create value when trading bonds on the secondary market. But if this type of value is created, it could also trigger the bond’s call feature because any underlying stock that develops an upward bias will push up the price of the corresponding convertible security. Although investors would lose the income stream from interest, they could still convert their holdings into the underlying common stock and hold it for potential appreciation.

Convertibles offer their issuer two distinct advantages:

1. Interest costs are lower if the company issues convertibles because an investor will accept lower interest in return for the potential to own common stock. This saves the company considerable amounts in interest. 2. If the underlying stock rises, the company can call the bond once the first call date passes. If the investment value of the converted stock exceeds the call price, the company can assume that the investor will convert the convertible securities into common stock. The conversion into stock eliminates any further interest payments on the securities that have been converted.

Important Considerations before Purchase of Convertible Securities 1. Current yield and yield to maturity 2. The amount of common stock appreciation needed to make conversion attractive 3. Growth prospects of the underlying stock (issuer quality, economic conditions) 4. Downside risk if the conversion privilege proves valueless 5. Timing of first call period 6. Amount of conversion premium

8 THIRD PARTY TRUST PREFERRED SECURITIES

Third Party Trust Preferred Securities are issued by a special trust that is set up by an underwriter, usually a major investment bank or broker. Then, the trust is funded by the underwriter for the purpose of buying a block of corporate bonds as a new issue, or in the secondary market. These bonds will have a semiannual interest payment and set maturity. They also may be callable.

Then, the trust issues $25 par value certificates, which, in total, would equal the exact amount of the block of bonds that they originally purchased for the trust. The semiannual payments from the underlying bond are then passed through to the certificate holder, quite often on a quarterly basis. These certificates trade on the NYSE and can be bought and sold at market prices. These prices could be at a discount or premium to the original issue price of $25. When the underlying bond matures, the trust will repay each certificate holder the par value of $25.

General Attributes of Trust Preferreds: • Issue Price – $25 per share (less common: $10 per share) • Dividends – from 5% to 9% a year. Payout is, for the most part, quarterly. The majority of Trust Preferreds have fixed dividends. Those few that are adjustable are pegged to U.S. Treasury rates. • Maturity – usually 30 to 50 years • Call Provisions – generally callable at par on or after 5 years from the date of issue. • Ranking – senior to the company's preferred stock and common stock; junior to . It would therefore be repaid after senior debt was paid. • 15% Tax Rate Eligibility – not eligible • Bankruptcy Clause – In the event of a bankruptcy, the trust has the option to sell the underlying bonds in the market place for whatever recovery value they can receive. These proceeds would then be distributed to the certificate holder. This option may or may not be exercised.

9 MUNICIPAL BONDS

States, political subdivisions, state agencies and primarily local governments issue municipal bonds, or munis, to raise money. Municipal issuers include, but are not limited to, cities, counties, school districts, utilities and public authorities, agencies and commissions. Today, municipal bonds are generally issued in denominations of $1,000 to $100,000 in $1,000 increments. Municipal bonds typically trade in $5,000 increments. Primarily, disclosure on municipal securities is made via a document called an official statement, which contains information about the new bonds, plus the legal statement that verifies a municipality’s authority to issue them. The issuer is then required to submit continuing disclosures on a regular and as-need basis.

Maturity and credit quality are two important features of municipal bonds. The higher the credit quality of the issuer, the lower the credit risk of the bond. A major benefit of most municipal bonds is their exemption from federal taxes. Additionally, if purchased by a resident of the state of issuance, most bonds will be exempt from state income taxes. Bonds issued by a territory or possession of the U.S. are exempt from federal, state and local taxes and therefore called triple-tax-exempt, such as bonds issued by Puerto Rico.

Generally, tax exemption enables municipalities to issue bonds with coupon rates below those of taxable fixed income securities. The higher an investor’s tax bracket, the greater the benefit to that investor of tax-exempt bonds. Accordingly, munis might not be appropriate for investors who receive special tax considerations. When seeking the best return, the investor needs to determine taxable yield versus municipal yield with the following formula.

Taxable Equivalent Yield = Municipal Yield 100% - tax bracket

If an investor in the 28% tax bracket buys a 4% muni at par, the individual would need to earn 5.56% on a fully taxable bond at par value (such as a ) to equal the muni’s tax-free yield.

Tax Equivalent Yield = 4% 4% 100%-28% tax bracket 72% = 5.56%

For an investor in the 35% tax bracket, the 9% muni would have a taxable equivalent yield of 6.15%.

Tax Equivalent Yield = 4% 4% = 6.15% 100%-35% 65%

10 MUNICIPAL BONDS (continued)

Types of Municipal Bonds

General Obligation Bonds (GO). Only entities that can levy and collect taxes may issue GO bonds. Typically issued by state and local governmental units or school districts, they are secured by the full faith and credit and taxing authority of the issuer and generally used either to fund general operating expenses or capital improvement funds. These bonds require voter approval and are subject to debt maximums.

Although unusual, municipal securities do carry the risk of default. Analysts studying a GO bond analyze the issuer’s overall economic health. They consider the fiscal responsibility of the issuer, as well as the trend of its debt and whether the issuer is proactive in addressing its need for funds. Issues such as its financial condition, unfunded pension liabilities, tax collection and real estate valuation also come into play.

Revenue Bonds. When a dealer/underwriter issues revenue bonds, payment of interest and principal is secured from revenues generated by the projects being financed by the bond issues. Issuers can be either governments authorized to issue debt or an agency created to issue bonds for the purpose of building and operating a project, such as a toll road, an airport, water and sewer systems, bridges and tunnels, colleges or . Revenue bonds may also be secured by lease payments, although these bonds tend to carry a slightly lower credit rating.

Revenue bonds are issued when the issuer cannot obtain voter approval for a GO bond levy. They can also be used to finance capital projects when an issuer has run up against statutory or state constitutional limits that prevent them from issuing GO bonds.

Various types of revenue bonds include: • Industrial Development Revenue and Pollution Control Revenue • Special Tax Bonds, payable from the proceeds of a special tax. These bonds may also be backed by the full faith and credit of the issuer. • Special Assessment Bonds, assessed from citizens who benefit from facilities such as water and sewer systems, sidewalks and streets. • Double-Barreled Bonds, backed by two pledged sources of security. . • Moral Obligation Bonds are secured from project revenues. Nevertheless, the state or state agency is morally obligated to prevent these bunds from defaulting. • Taxable Municipal Bonds are issued when a state has exceeded its maximum issuance of private activity bonds.

Private Activity or Alternative Minimum Tax Bonds are issued if 10% more of bond proceeds will be used to finance a project used by a private entity (such as a sports team) and if 10% or more of the bond proceeds will be secured by property used in the issuer’s business.

11 MUNICIPAL BONDS (continued)

An important factor in a revenue bond’s creditworthiness is a comparison of the revenue stream available to the amount of debt service that the issuer must pay. This comparison is usually made by a feasibility study. Along with the trust indenture (also called the bond resolution), the feasibility study will be analyzed by rating agencies. Both the feasibility study and the indenture appear in the Official Statement that must accompany municipal bonds. This statement makes certain pledges for the bondholders’ protection. Among these protections are rate, maintenance and insurance covenants; financial reports and audits; whether or not additional bonds may be issued; a nondiscrimination covenant and a catastrophe bond.

Revenue bonds should create a stream of funds to provide for the bonds’ security as they pay for operations, debt service and reserves.

Oppenheimer & Co. Inc does not offer tax advice; you should consult with your tax adviser regarding the suitability of tax-exempt investments in your portfolio. Income from municipals may be subject to state and local taxes as well as the Alternative Minimum Tax. Municipal Securities are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer.

12 PRE-REFUNDED BONDS— LIQUID, TAX ADVANTAGED

Pre-refunded bonds are backed by an irrevocable escrow of U.S. Treasury securities, which generally carry a “AAA” rating. A municipality pre-refunds bonds when it decides to refinance higher-interest-rate debt with bonds issued in a lower-interest-rate environment. For example, a municipality that has an outstanding issue maturing in 10 years with a 5% tax free coupon is callable in two years. The municipality might be in a position in an environment where interest rates are lower, or its credit rating has improved, to issue a new bond with a lower coupon. This bond (with a lower coupon) will replace the old bond, thus reducing their interest costs. The following steps will be an example of a pre-refunding…..

Step 1. A municipality has an outstanding issue that matures in 10 years with a 5% tax-free coupon. The bond is callable in two years. Assume that the municipality would be in a position to issue a new bond, in the same amount, also due in 10 years, at a rate of only 3%.

Step 2. The municipality uses the proceeds from the 3% issue to buy Treasuries that mature in two years, the same maturity date as the call feature of the 5% bonds.

Step 3. When the government bonds mature, the proceeds are used to finance the call in feature of the 5% bonds. The interest paid to the municipality from the government bonds helps to offset the 3% being paid on the new bonds.

Conclusion. In this manner, the municipality has reduced its interest cost from 5% to 3% for the remaining 8 years on the 3% bond. Investors who buy the old 5% bonds while they are escrowed by U.S. treasury are receiving a tax-exempt yield while essentially owning security backed by the U.S. government.

In addition to high credit quality and higher yields, pre-refunded bonds offer investors:

• Shorter Maturities. Pre-refunded bonds tend to be called early or to mature within five to ten years. As a result, investors can benefit from the bonds’ income stream without locking up their initial investment for long periods of time. • Relatively Stable Prices. Although pre-refunded municipals tend to be issued in anticipation of falling interest rates, their higher-coupon interest rates limit their price volatility when interest rates rise. • Tax Advantages. Most municipal bond income is exempt from federal taxes and, in some cases, from state and local taxes as well. All municipal bonds do carry a legislative risk that Congress will do away with the federal or state income exemptions which would reduce their effective yields. Investors should also be aware that pre-refunded bonds raise a number of financial and tax questions that investors may want to discuss both with their financial advisors and tax professionals. • Premium Pricing. An investor holding pre-refunded bonds to maturity is likely to receive par value, or less than the bonds’ premium purchased price. If these bonds are called before the cash flow equals or exceeds the premium, or if the investor wishes to sell the bonds on the secondary market before they are called, the yield realized by the investor may be somewhat diminished. • AMT Risk. Pre-funded bonds’ ability to provide tax-advantaged income streams may put investors at risk of the Alternative Minimum Tax, which can boost them into a higher tax bracket. • Reinvestment. If investors sell pre-refunded bonds, depending on the interest-rate environment, when the bonds mature, they lose that income stream and may not be able to find investment opportunities that pay an equivalent amount.

13 CONCLUSION AN ESSENTIAL ASSET CLASS

Historically, bonds and other fixed income securities have been the portfolio element that has provided stability because of their relatively low correlations with equities. As such, they are an integral part of an investor’s portfolio. They become an even more important aspect of a portfolio as its owner matures and becomes more interested in capital preservation than aggressive capital growth.

An allocation of a portion of an investor’s portfolio to fixed income securities, and especially bonds, can enhance its stability of returns and potentially reduce its volatility, compared with an all-equity portfolio. Thus, in times of stock market turbulence, investors have tended to flock to the safe – or safer – haven of the bond market, while, in times of rising stock markets, investors use bonds to hedge their investments, or help protect against downside risk.

14 DEFINITIONS

Callable Bond A bond that may be redeemed by the issuer prior to maturity on specified dates and specified prices Convertibles Debt, usually subordinated debentures or preferred stock issued by a corporation. These convertibles may be exchanged for a fixed number of the issuing corporation’s common stock. Corporate Bonds Debt securities issued by a corporation or government; possessing a stated interest rate and fixed due dates when interest and principal must be paid. Specific features are written into each bond’s indenture. Coupon The rate of interest on a debt security that the issuer will pay to the holder until the bond matures (is retired). The coupon rate is expressed as an annual percentage of face value (most often, $1,000 for corporate bonds) and can be paid annually, semiannually, quarterly or monthly. Credit Rating Formal evaluation of a company’s financial health and ability to repay debt. Current Yield Annual interest on a bond divided by the cost of the bond A long-term corporate debt instrument issued without collateral and secured only by the general credit of the issuer. Documented by an indenture. Default Failure of borrower to pay interest or repay principal in a timely manner. Discount Bond A bond that is offered below its face, or par value. Indenture The contract between a bond’s issuer and the bondholder. The indenture states the bond’s terms, including time before call (if callable), repayment, interest rate, whether or not the bond is convertible and at what terms/ratio. Investment Grade Debt Considered suitable for purchase by prudent investors. Bonds rated Baa3 and above by Moody’s and BBB- and above by Fitch and S&P are investment grade securities. Junk (Speculative Grade) Bond Bonds rated below investment grade debt, carrying a rating of less than BBB by S&P and Baa by Moody’s. Liquidity The ability to trade bonds without causing major price fluctuations or searching for a market; also, the ability to realize principal when it is needed. Maturity The date at which the loan becomes due and the borrower must repay the lender principal (par) and the last interest payment. Most bonds have a fixed maturity date. Some may be called prior to maturity, while others may be extended, with the result that these bonds may be putable, or sold back to the issuer. Original Issue Discount A bond with its par value discounted at the time that it is issued. The difference between the purchase price and the adjusted price is considered income, in addition to any interest that may be paid. If the bond is held to maturity, no capital gains tax will be paid since the gain is considered interest. Par Bond Bond whose market value is equal to its redemption value, usually $1,000 per bond. Premium Bond Bond selling at a price that is higher than its face, or par, value. The amount by which the price exceeds the bond’s face value is the premium.

15 DEFINITIONS (continued)

Putable Bond A bond stipulation specified in the indenture that allows either the holders or the issuer to redeem the issue on specified dates prior to maturity at face. Redemption The redemption of a debt security or preferred stock issue at or before maturity at par or at a premium. Subordinated Debenture An issue that ranks after secured debt and debentures in its claim on assets. Owners of this kind of bond stand last in line among creditors, but before shareholders. Total Return Includes both interest and price change, usually as an annualized rate, with all interest reinvested. Yield The dividends or interest that a security will earn. Yield is expressed as a percentage of the amount paid for the security or the security’s par value. Yield to Call The average annual return of a bond calculated from the purchase date to the call date and call price. Yield to Maturity (YTM) A debt security’s average return based on its interest income, capital gains or capital losses incurred until the security matures. Yield to maturity assumes that the coupon payments can be reinvested at an interest rate equal to the yield to maturity. Yield difference between two bonds or bond indices, measured in basis points.

16 ABOUT OPPENHEIMER

Oppenheimer & Co. Inc. (Oppenheimer), a principal subsidiary of Oppenheimer Holdings Inc., provides a full range of wealth management, securities brokerage, capital markets and services to high-net-worth institutions, businesses, individuals, families and corporate executives.

Oppenheimer is committed to helping its clients meet their financial needs by providing independent financial advice, a comprehensive suite of product solutions and responsive client service.

More than 1,300 Oppenheimer Financial Advisors, with extensive experience in the industry, help clients grow, manage and preserve their financial assets. With offices located throughout the United States and in South America, and investment banking offices in the U.K., Asia and Israel, Oppenheimer has a unique combination of local presence and national resources that enables its professionals to provide attentive, personalized service and talented solutions customized for each client.

Clients have access to a broad array of traditional and specialized products and services to help fulfill their financial needs. Institutional clients globally may benefit from Oppenheimer’s balanced reach, its investment banking capabilities and the seriousness with which it addresses its fiduciary responsibilities.

Oppenheimer’s Financial Advisors are able to draw upon the experience of specialists whose knowledge and dedication to enhancing the risk/reward profile of fixed income portfolios can add value to the investment process. Oppenheimer’s bond professionals are specialists, with separate investment teams for taxable and tax- exempt securities. They are conservative, risk-averse fixed-income investors able to evaluate market opportunities and analyze the value and quality of each security they consider.

Finally, Oppenheimer’s advisors and other professionals are extremely client-oriented. They offer clients a high degree of access to all of the company’s fixed-income resources. Active, professional fixed income investing through Oppenheimer can help to enhance portfolio returns and reduce risk by applying the company’s capabilities to make well-informed investment decisions.

17 This presentation is intended for informational purposes only and does not purport to be a complete analysis of securities, market segments or strategies discussed. It is subject to change without notice. Any discussion of securities should not be construed as a recommendation or an offer or solicitation to buy or sell interest in any such securities. Securities products offered or sold by Oppenheimer will not be endorsed or guaranteed by Oppenheimer and will be subject to investment risks, including the possible loss of principal invested.

Income from municipals may be subject to state and local taxes as well as the Alternative Minimum Tax. Municipal Securities are subject to gains/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Please contact your tax adviser regarding the suitability of tax-exempt investments for your portfolio.

Non-rated bonds/preferred stocks or bonds/preferred stocks rated below investment grade may be speculative in nature and are not suitable for all investors.

Oppenheimer, nor any of its employees or affiliates, does not provide legal or tax advice. However, your Oppenheimer Financial Advisor will work with clients, their attorneys and their tax professionals to help ensure all of their needs are met and properly executed.

No part of this brochure may be reproduced in any manner without the written permission of Oppenheimer.

©2010 Oppenheimer & Co. Inc. Member of All Principal Exchanges and Member SIPC.

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