(FORTUNE Magazine) – IN A YEAR when short-term interest rates fell like a safe dropped from a tenth-story window, who can blame the fixed-income investor for feeling crushed? After all, the poor guy who complained a year ago about the 6% yield on his two-year Treasury note is now looking at less than 4%. It gets worse: Six-month T-bills throw off a mere 2.9%, the lowest in 30 years. With a yield like that, pay your taxes, adjust for inflation, and you're losing money. Even junk fanciers have seen their double-digit yields wilt, from 11.4% a year ago on BB-rated bonds to 9.5%. Despite these grim developments, the bond world still offers rewards:

-- TREASURIES. Given the unusual steepness of today's yield curve -- in which the interest jumps to 5.3% on five-year T-bonds -- most analysts expect the year ahead to again favor those who shun short-term bonds. With longer maturities, declining interest rates bring the added consolation of capital gains; bonds of a fixed-interest-rate coupon rise in value as market yields decline. Salomon Brothers calculates that, combining coupon income with price appreciation of 7.2%, holders of Treasury bonds with maturities of 20 years or more pocketed a handsome 15.9% return over the past 12 months. Of course, the longer the maturity of the bond, the more volatile the price. The optimum tradeoff occurs at five to ten years, where you pick up twice the yield of short-term bonds without risking all the price fluctuations of a 30- year Treasury. In the intermediate-term area, says Ian MacKinnon, head of fixed income at the Vanguard Group, ''you get paid so much to go out on that curve that you more than make up in yield what you risk in principal.'' Analysts warn bondholders not to expect much more price appreciation from a further decline in interest rates. But you probably won't lose much principal either, which would happen in the unlikely event that interest rates quickly reversed and rose sharply. That would take a heated economic recovery, which nobody is predicting.

-- MUNICIPALS. Individuals intent on lowering their tax bill should head to the statehouse and city hall. Chances are that cash-strapped states and municipalities will be asking you to lend a bit more to keep the wheels of government turning. ''In terms of tax shelters, munis are the only game left in town,'' says James Cooner, manager of tax-exempt bonds at Bank of New York. The argument for buying them has seldom been stronger. Cooner estimates that high-quality intermediate munis currently yield about 85% as much as Treasuries with comparable maturities, far above the usual 77% ratio. For those in the 28% bracket, that's equivalent to a 7.5% taxable yield. These securities are cheap -- and high-yielding -- because of the huge supply coming on the market. Cities and states are furiously issuing new bonds to take advantage of current low interest rates. This depresses prices in the short run but could actually be a boon to bondholders later on. Vanguard's MacKinnon estimates that more than a quarter of the $1 trillion of outstanding municipal bonds are actually bonds that have been issued in advance to refinance older, high-coupon bonds that can be called for early redemption at a set date (see box). While the municipality waits for the call date to arrive, the old bonds and the new bonds coexist, bloating the supply. Once that date comes, the old bonds get yanked out of the pool, reducing supply and leaving their holders with a fistful of cash. Now the boon, as envisioned by MacKinnon: ''Chances are, they'll plow that cash back into the muni market and push prices up.''

-- MORTGAGE-BACKED. Investors in securities such as Ginnie Maes know all about refinancing. As interest rates dropped, homeowners rushed out to trade in their old, high-interest loans for cheaper mortgages, returning the principal to investors far more quickly than expected. When that happens, a Ginnie Mae that yields a tempting 8.5% may not be such a good deal after all. If that 8.5% comes from a bond with a 10% coupon for which you paid a price premium above par, and you get back only 100 cents on the dollar when the homeowner pays up, bid goodbye to a chunk of your principal. Because interest rates are unlikely to spike back up to levels that would substantially slow the current high levels of early repayment, Wayne Oliver, head fixed-income portfolio manager at Equitable Capital Management, tells investors to tread warily. ''I'm not sure this is the time to invest in high-coupon mortgage securities,'' he says.

| -- CORPORATES. The corporate bond sector is no screaming buy either. Yields on investment-grade corporates have declined relative to Treasuries in the past year and are now only about half a percentage point higher. Put another way, corporate bonds have risen faster in price than Treasuries. The good news is that the yield spread investors enjoy will shrink no further. Peg Hadzima, director of global bond research at the mutual fund firm of Scudder Stevens & Clark, likes the bonds of selected banks that are profiting from the gap between short- and medium-term interest rates.

-- JUNK. True mouthwatering yields, and returns to go with them, lurk in the high-yield corporate bond sector. Investors who held junk collected an impressive 23% return in the past 12 months, about half of that in price appreciation. But beware: When high-yield bonds were in the doghouse two years ago, junk bonds paid investors eight percentage points more than Treasuries. Since they began their phoenixlike ascent, that premium has shrunk in half. With this in mind, Margaret Patel, head of fixed-income investments for Boston Security Counsellors, is only cautiously optimistic about the market. She looks for junk to pay investors about 10% next year, almost all in interest payments.

-- FOREIGN BONDS. If roller coasters are your idea of fun, you may want to venture into the foreign bond arena. In recent weeks, as European currency markets convulsed, Americans watched the value of their high-yielding global funds move up and down faster than they could say Maastricht. Despite the head-spinning nature of this investment, bond managers still think you can do well by going global if you stick it out over the long term. Says Leslie Nanberg, who manages the MFS Worldwide Government fund: ''You'll make higher current income and greater capital gains by being outside the U.S.''

CHART: NOT AVAILABLE CREDIT: JIM MCMANUS FOR FORTUNE/SOURCE: SALOMON BROTHERS CAPTION: YIELD TO MATURITY BACK TO EARTH In hindsight, the dizzying interest yields of the early and middle 1980s -- along with no-brain investing -- were anomalies.