I get how a single bond works. You buy the bond, hold it to maturity. The company pays you quarterly\semi-annually interest payments of x% and the entire principal when the bond matures. Your risks are:
- Credit Risk - The company COULD default but a big reputable company with AAA rated bonds is LIKELY not going anywhere.
- Opportunity Cost - If you hold a bond that pays 4% and rates are at 10% you are "losing". You COULD sell your bond at a loss and buy something else. You don't have to though and don't lose any real money besides the opportunity. You still get your 4% + coupon.
Point 2 seems to be mitigated if you simply just hold the bond to maturity. You get your 4% for 15 years, it's safe, and you are happy with it. If you don't sell the price doesn't matter. Is it even in your best interest to sell your current bond and buy another one at the "new" 10% rate?
With a bond fund it's just like a stock. It goes up and it goes down. As interest rate rise the fund drops. I assume the price isn't all that's baked into it as the underlying asset is... well bonds.. and these things pay quarterly\semi-annual interest payments that can be reinvested.
With that being said, how do you value these things? With a single equity you just care about price. With a single bond you just (for the most part) care about credit risk. With a bond fund, there's both price and interest. For example.
Let's say you bought a long term bond fund at $100 that pays an average of 4% per year. Ten years later you sell it at $80. The bond fund dropped 20% in value BUT you made 4% per year for 10 years. Did you win? Or would the numbers never work like this in reality?
Also I would assume as the bond fund prices drop the interest paymenrs get higher since newer bonds that are brought into the fund do so at a higher interest rate (the fund is buying new bonds at the market rate which pay higher interest and thus raising the "average interest paid" over all the bonds). Does it all "even out" as in the drop in price is perfectly offset by the rise in rates so it means nothing.
TLDR: What metric do you look at with a bond fund? How do you think about them and value them?
Submitted April 05, 2017 at 07:45PM by EEEUUUDDDGGG23 http://ift.tt/2oKxUui
