Understanding Bonds

The price of bonds is directly related to the level of interest rates. If interest rates go down the price of bonds will go up. If interest rates rise, the price of bonds will go down. Note the significance of the term to maturity of the bond. As the maturity of a bond increases, its market value becomes more sensitive to changes in interest rates. The longer the term of the bond, the more profound the change in market value.

Buying a bond fund managed by a mutual fund company is one way to participate in the fixed income market. Generally, the cost (management expense ratio) for bond funds is much lower than the cost charged on equity mutual funds or for smaller bond transactions. Bond funds provide a low cost method of getting fixed income exposure without the potentially high costs brokers may charge to handle individual trade transactions.

A problem with bond funds is that while the average maturity of the holdings may fit with your objectives when purchased, the funds objectives may change, which in turn could lead to different maturity and credit quality exposure than you may want. This problem may be addressed by certain funds. While they do not set it out in the funds’ prospectuses, they adopt a management policy that is well-documented and which undertakes to stick to specific ranges for such things as credit quality and average maturity duration.