Thanks for your response dbr. I know and appreciate the main points in your first two paragraphs, including the generally more dynamic management nature of a bond fund. The last half of your final paragraph exceeds my capacity for understanding. I think the bottom line for me is that leaving aside other considerations (e.g., an individual bond ensures return of X amount of principal on a specific date, ongoing management and turnover in a bond fund maintains an average target duration, etc.) individual bonds behave like comparably matched bond funds at any given point in time. Others have already pointed out the advantages of using a professionally-managed bond fund. The predictabilty of dates of principle return with a bond ladder may be important for some, but otherwise I don't see any advantage to buying individual bonds. Total bond market (e.g., BND) is simple, easy, more safe, and works fine for me.The difference between holding a set of bonds yourself and a bond fund holding a set of bonds is that the bond fund is managed by buying and selling to maintain a target distribution of properties, including duration, for example. Your individual set of bonds will migrate closer and closer to maturity and eventually mature away. The bond fund does not do that. In the case you hold a rolling ladder you do replace bonds and maintain a duration. A rolling ladder of bonds is not fundamentally different from a bond fund.I'm confused by posts that suggest that, all other things being being equal, holding individual bonds is different from holding a bond fund in terms of stability of income or principle. Won't a basket of individual bonds with the same credit rating and maturity of a bond fund behave in the identical way to changes in interest rates? For example, if interest rates suddenly go up, won't the market prices of the individual bonds and of the bond fund decline to an identical amount? And doesn't the income thrown off by both the basket of bonds and the bond fund essentially stay the same for a current shareholder despite the declines in market price? The coupons haven't changed, just the discount in the price. Am I missing something?
In a similar fashion, isn't a bond ladder somewhat akin to holding several bond funds of different average maturities? I understand that a bond fund, unlike an individual bond, never actually reaches maturity, but at any given moment how would the current market value and interest income of individual bonds react any differently than a comparable bond fund?
You are correct that the prices of your set of bonds vary with interest rate but that effect also varies with how far along to maturity all the bonds are. It is also true that the actual cash flows from your bonds are a constant. This does not apply to a bond fund or a rolling bond ladder because of the constant replacement of old bonds with new ones that have different terms.
The relationship between price and yield is not a simple inverse. The relationship between coupon interest rate and price is a simple inverse. The definition of yield to maturity is that it is the interest rate that used as a discount to obtain the net present value of the cash flow gives a total NPV equal to the price. The redemption face value is one of the cash flows and is not necessarily equal to the present price until maturity.
The effect of change in yield on price is measured by the modified duration. Modified duration is the log derivative of the price (as above) with respect to yield, so it is an operation on an expression that captures the time value of money.
Statistics: Posted by Rocinante Rider — Sat Aug 17, 2024 1:29 pm — Replies 29 — Views 854
