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Subject:  Re: Vanguard Talk on Bond Fund NAVs Date:  6/9/2004  5:53 PM
Author:  Lokicious Number:  10265 of 35992

"A question, as I am not familiar with bond/bond funds."

What is the good source for a newbie to learn the basics of bond investing?"

Welcome aboard,

A lot of us were where you are not so long ago (I started looking into bonds about 3 years ago). Probably my best source was Vanguard's web site: they have a lot of explanatory links (though you have to dig), and there's much to be learned about how bonds of different sorts work (not just funds) by downloading their PDFs for prospecti and annual reports from different bond funds. There are also several reference books on bonds, which others here have tried.

Suppose today I buy 10 year treasury bond worth 10K yielding 4.8%. Does this mean

1) As long as the bond price doesn't change, I will get $480/year.

2) Suppose the bond loses its value and it is now worth 9K, but the yield is 6%. Does this mean I will get interest payment of $600/year?

3) Also no matter what the yield is on maturity, will I get back my principle 10K?

Let's start by assuming you buy a 10K 10-year treasury with 4.8% yield and hold onto it for 10 years until it reaches maturity. You will always get $480 per year, and at the end of 10 years you will get back your original $10K, Of course, if you put your $480 into something else each year, your compound yield will be a bit higher than 4.8%.

At no point will your bond start yielding 6%. That can happen with a bond fund, where the daily NAV fluctuates based on the tradeable value of the bonds it holds, and as it buys and sells bonds in changing interest rate environments, the yield on the fund goes up and down. But the bond you buy for yourself doesn't change yield (unless you buy TIPS, where they yield changes in relation to inflation, though the fixed portion of the yield never changes).

Now, if you sell the bond before 10 years, you will probably sell at a loss or a gain to accommodate changes in interest rates. You calculate how much the bond is worth by multiplying the change in basis points as a percent times the number of years remaining until maturity: so if, in your example, interest rates went up to 6% on 10-year treasuries in two years, you would have to sell your bond for a loss of 120 basis points (1.2% points change) times 8 years or 9.6%, i.e., it would be worth $9040 instead of $10000.

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