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Introduction to Bond Funds: Interest-Rate Risk and Credit Risk

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To bond investors, interest-rate risk and credit risk are the big risks to consider. If you have a bond fund, you should monitor them.

What you will learn

  • Understand Interest-Rate Risk
  • Understand Credit Risk

What do you know?

Introduction to Bond Funds: Interest-Rate Risk and Credit Risk

Glazed eyes. Gaping mouths.

Bond talk is generally considered a sure-fire way to put your dinner companions to sleep. We're convinced that this is largely because people don't really understand the basics of bonds and like everyone—yes, everyone, including the media and a lot of so-called market "experts"—they're terrified by the fixed-income world.

If you're going to choose a bond fund, the harsh truth is that you need to know what a bond is. When you buy a stock, you become part owner of the company. When you buy a bond, you are making a loan; you are simply lending money to the company (or, in the case of Treasury bonds, to the government). Your loan lasts a certain period of time—until the date that the bond reaches maturity. In the meantime, you can typically expect dividend payments (commonly known as coupons) as interest on the loan. Thus, the essential issues for bond investing will be the bond's maturity and how confident you are that the business or government can actually repay the loan.

In the next two articles, we'll quell that terror of the fixed-income world, detailing what you need to know before choosing your first—and perhaps only—bond fund.