August 21st, 2009 by admin

Definition of Bond funds

Bond funds invest in various types of fixed-rate debt securities with the aim of maximizing the income from the capital provided by investors. As with other mutual funds, investors buy shares in the fund at a price determined by the fund’s NAV (net asset value) divided by the number of outstanding shares. Most bond funds pay a monthly dividend based on the interest earned by the securities in the fund portfolio. The most common types of bond funds are those that invest in government or in corporate bonds. Some bond funds focus on long-term bonds while others invest in those with short maturities .

Risk of Bond funds

Bond funds are not without risk, although they are safer than stock mutual funds aimed at equity growth. The principal concern for investors is interest rate risk. When prevailing interest rates rise, bond prices fall. This reduces the NAV of a bond fund and hence the investor’s equity. Conversely, if interest rates fall, bond prices tend to rise, increasing equity but tending to reduce yields and therefore the dividends paid by the bond fund. Credit risk and the chance callable bonds may be redeemed early (discussed above) are other factors an investor should consider. Finally, some bond funds invest in international debt securities. These carry a special risk because changes in foreign currency exchange rates can impact the value of the bond fund’s assets and dividends.

Selecting Bond Funds

Like all mutual funds, bond funds are regulated by the Securities and Exchange Commission, which requires the fund to provide investors with a prospectus updated annually. The prospectus discloses the fund’s performance history, fee structure and management record. This is where a prospective investor should start when evaluating a bond fund as a possible investment. Independent analysis of bond funds is readily available as well from financial research firms such as Morningstar (Morningstar.com) and Crane Data (cranedata.us).