Question: In 1973 we bought $20,000 worth of AT&T 8.75 percent bonds, paying a premium of 109 for them. Now they are quoted at around 80! Should we continue to hold these bonds? Sell them? Or buy more to average the price down ?

Answer: Let's take care of the last -- and easiest -- question first. Don't go chasing a falling price simply to bring down your average cost; statistically you can't ever catch up.

Any further purchase should be considered a separate transaction, to be entered into only because it makes sense on its own merits.

A decision on wheter to hold or sell requires more information then was in your letter -- things like your age, other investments, tax bracket, investment objective. But we can talk in general terms about the considerations involved.

In the first place, your decision to buy the bonds was not necessarily wrong. Hindsight is a great teacher -- but looking ahead in 1973 there was no way for you to know in what direction interest rates (and, inversely, the bond market) were going to move.

The bonds were bought, I presume, as a conservative investment calculated to yield an income of $1,750 a year. There are doing precisely that; and at maturity you are highly likely to get back the full face amount of $20,000.

The risk of loss of either principal or interest is minimal with these highly rated (AAA) bonds. And repayment of the principal in full in the year 2000 is not affected by interim changes in market value.

But there may be a tax advantage in selling now. If you were to sell at 80, you would generate a long-term capital loss of $5,800. If you're in, say, the 37 percent tax bracket, you can come up with a federal tax saving of $1,073 (plus a lesser amount on your state tax return).

Then you can turn around and immediately apply the $16,000 proceeds from the sale to purchase comparable bonds. For example, you could buy another AT&T issue due in 2005 with a coupon rate of 8.80 percent.

As of mid-April, your $16,000 invested in these bonds would produce an income of $1,730 a year. And if you were to add the $1,100 or so in tax savings to the $16,000, the total (invested in these alternative bonds) would bring you about $1,850 a year -- roughly $100 a year more than your present holding.

Of course when the new bonds are redeemed at maturity (in the year 2005), you will be liable for tax on a long-term capital gain of about $3,800 -- but I wouldn't lose any sleep worrying about that right now.

Q: My husband died last year and left several insurance policies, from which I received monthly payments. One insurance company says the payments are all taxable; but another one says that the money may be partly tax-exempt. Which one is right ?

A: Probably both of them. The tax status of payments received by a surviving spouse as beneficiary of a life insurance policy depends on the payment option selected. (We're talking now about income tax; estate or inheritance tax is a different ballgame.)

This situation arises when the proceeds of the insurance policy are left with the issuing company. If you are getting only the interest on the proceeds (the prinicipal remaining with the company), then all of the interest received is taxable income to you in the year received.

But if an "installment option" had been selected -- that is, if your monthly payment consists of both interest and a part of the principal proceeds -- then up to $1,000 of the interest received each year may be excluded from income.

Check with the insurance companies involved to find out what settlement option applies in each case.

Incidentally, the $1,000 annual exclusion applies to the total received on all policies, not on each policy individually.

Q: If I sell my house, do I have to put all the cash from the sale into a new house in order to defer the tax ?

A: No. In fact, you don't have to apply any of the proceeds from the sale to the purchase of the new residence.

The use to which you put the cash realized on the old home has no bearing at all on your qualification for deferral of tax on any gain.

You need only meet the timing requirements and buy a new home that costs at least as much as the adjusted selling price of the former home to qualify. See IRS Publication 523 for all the details.