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Subject:  Re: Investing in bond funds for trip down Date:  9/12/2007  2:40 PM
Author:  Lokicious Number:  21581 of 36686

guess the part that is most confusing is that there is a gain when the price goes up and I'm not sure how yeild or NAV affects that. Maybe using numbers will help explain it. For example:

Buy: 100 @ $10.00
Sell: 100 @ $11.00

That results in a gain for your portfolio plus any monthly payouts that were accumulated. If during the time I'm holding that fund, buyer demand decreases, are you saying the price is not likely to reach $11.00 and could in fact go below $10.00? In that case, it's clear there will be a loss. It also means the bond trails the market decline. Bonds and stocks declined together in other words.

If the only affect is that the monthly payments decrease, it doesn't matter so much because there is still a gain to be had from the price increase.

I'm not sure I understand your example.

Let's look at a real example, using Treasuries, not a fund. (A fund holds a portfolio of bonds, so it is more complicated, but ultimately works the same way.)

On May 15, 30-year Treasury bonds were auctioned with a 5% coupon. Right now a $1000 face value 30-year bond from that auction can be sole for approximately $1050 (ignoring commission). That's a 5% gain, if you chose to sell. The current yield on the bond is 4.68%, which is how much interest you would be paid each year if you bought the $1000 bond for $1050. The yield is 32 basis points lower than the coupon (the actual dividend the bond pays each year).

On May 15, 3-year Treasury Notes were auctioned with a 4.5% coupon. They are currently trading for about $1010 for $1000 face value with a yield of 3.98%. So, there is a 1% gain in value on the bond with 52 basis points difference between coupon and yield.

See Bloomberg for #s (which will likely have changed by time you look, but not by too much).

This example is with interest rates going down. If interest rates go up, the opposite will happen: the tradable value of the bond will go down (e.g., if you paid $1050 for $1000 face value, you might sell for $1000) as the yield goes up.

A fund's NAV is its share price. If the value f the bonds owned by the fund goes down, the share price goes down. You can approximate his by multiplying change in the fund's yield by the fund's duration (which you will find listed for Vanguard on the link for the fund's holdings).

CUrrently for Vanguard's long Treasury fund, the yield is 4.6% and the duration 10.4%. So if Hedge guessed correctly at next May's 30-year auction the new coupon is 7%, the fund's would lose approximately 27%. Now, you would end up getting a somewhat higher dividend, but it is going to take an awfully long time to make up for a 27% loss.
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