Bond Mutual Funds !

Bond funds invest primarily in securities known as bonds. A bond is a type of security that resembles a loan. When a bond is purchased, money is lent to the company, municipality, or government agency that issued the bond. In exchange for the use of this money, the issuer promises to repay the amount loaned (the principal; also known as the face value of the bond) on a specific maturity date.

In addition, the issuer typically promises to make periodic interest payments over the life of the loan. A bond fund share represents ownership in a pool of bonds and other securities comprising the fund’s portfolio. Although there have been past exceptions, bond funds tend to be less volatile than stock funds and often produce regular income. For these reasons, investors often use bond funds to diversify, provide a stream of income, or invest for intermediate-term goals. Like stock funds, bond funds have risks and can make or lose money.


Types of Risks:

Interest Rate Risk: Think of the relationship between bond prices and interest rates as opposite
ends of a seesaw. When interest rates fall, a bond’s value usually rises. When interest rates
rise, a bond’s value usually falls. The longer a bond’s maturity, the more its price tends to
fluctuate as market interest rates change. However, while longer-term bonds tend to
fluctuate in value more than shorter-term bonds, they also tend to have higher yields
(see page 24) to compensate for this risk. Unlike a bond, a bond mutual fund does
not have a fixed maturity. It does, however, have an average portfolio maturity—the
average of all the maturity dates of the bonds in the fund’s portfolio. In general, the
longer a fund’s average portfolio maturity, the more sensitive the fund’s share price will
be to changes in interest rates and the more the fund’s shares will fluctuate in value.

Credit Risk Credit risk refers to the “creditworthiness” of the bond issuer and its expected ability to pay interest and to repay its debt. If a bond issuer is unable to repay principal or interest on time, the bond is said to be in default. A decline in an issuer’s credit rating, or creditworthiness, can cause a bond’s price to decline. Bond funds holding the bond could then experience a decline in their net asset value.

Prepayment Risk Prepayment risk is the possibility that a bond owner will receive his
or her principal investment back from the issuer prior to the bond’s maturity date. This
can happen when interest rates fall, giving the issuer an opportunity to borrow money
at a lower interest rate than the one currently being paid. (For example, a homeowner
who refinances a home mortgage to take advantage of decreasing interest rates has
prepaid the mortgage.) As a consequence, the bond’s owner will not receive any more
interest payments from the investment. This also forces any reinvestment to be made in a
market where prevailing interest rates are lower than when the initial investment was
made. If a bond fund held a bond that has been prepaid, the fund may have to reinvest
the money in a bond that will have a lower yield.

Are Tax-free Bond Funds Right for You?

With most bond funds, the income you receive is taxable as ordinary income. However, some funds invest in bonds whose interest payments are free from Government income tax, while other funds invest in bonds that are free from both gvt and state income tax. Tax-exempt funds may be subject to capital gains taxes.

The income tax benefit typically means that the income from these funds is lower than
that of comparable taxable funds. But if you compare the yields after taxes, a tax-free
fund may be a better choice, depending on your tax bracket.


>>>> Bond credit ratings represent the opinion of independent agencies on the likelihood that a
bond’s issuer will be able to make periodic interest payments and repay principal.