Stupid Bond Question

[luckyiknow]

I have a lot of my money in short and intermediate term municipal bonds, but the question would apply to any bonds I assume. When I read about bond markets "tanking" or getting "slammed," I never really understand--I get that they're talking about the market value of the bonds and that yields and market price are inversely correlated. But if the market price of your bonds go down isn't the solution to not sell them? When the bonds mature I'll get back all my principal (put aside default risk for the present discussion). So why do I care about the trading value of my bonds?

[brewer12345]

Quote:

Originally Posted by luckyiknow I have a lot of my money in short and intermediate term municipal bonds, but the question would apply to any bonds I assume. When I read about bond markets "tanking" or getting "slammed," I never really understand--I get that they're talking about the market value of the bonds and that yields and market price are inversely correlated. But if the market price of your bonds go down isn't the solution to not sell them? When the bonds mature I'll get back all my principal (put aside default risk for the present discussion). So why do I care about the trading value of my bonds?

If you are buying funds you are a total return investor whether you know it or not. That means that the hoped for return comes partly from interest and partly from capital gains. So you do care about the market value of your bonds. It affects your ability to rebalance, the amount of your net worth, etc.

[audreyh1]

If you are rebalancing. Not everyone does.

[pb4uski]

If you hold individual bonds to maturity, then decreases in the market value resulting from increase in interest rates don't really affect you... the change in value only affects you if you sell before maturity.

If you have bonds funds, then it is a whole different kettle of fish as it takes some time for the higher interest from bonds the fund is purchasing currently with proceeds from maturities and new money to offset the decline value of bonds the fund held when interest rates decline.

That is why I currently prefer target maturity bond funds to mitigate interest rate risk... they behave similar to a pool of individual bonds that mature in a stated year.

[papadad111]

As others have said. If you hold individual bonds and hold to maturity, the interest rate risk is irrelevant.

As long as you don't need to sell at some point in the future and hold all bonds to maturity, the only thing u may see is a portfolio marked to market ( statement value) that is a lot lower than the future maturity value (due to and assuming a rise in interest rates)

[NW-Bound]

If interest rate rises, usually that means inflation also rises.

You can wait, say, 10 years from now to get back your $10K, or you can get the $9K that the market gives you now and re-invest at a higher rate.

Though we have been in a low inflation period, it's still 22% cumulative over the last 10 years. $10K in 2005 is worth only $8.2K in 2015. Man, if they call that low inflation, I hate to think about even higher inflation rate.

[luckyiknow]

To clarify, I own individual municipal bond issues. When I get a statement, it shows the total value of my holdings which I assume is based on market. If so I usually ignore it because I assume the bonds will be held to maturity.

[John467]

For these reasons, I too have purchased some target maturity date bond funds from Guggenheim. On the surface, I get the advantage of a large number of bonds, bought at institutionally good prices, and immune to rising interest rates since the bonds are held to maturity. However . . . Is anyone out there concerned about this scenario: rising rates drop the current NAV of the target date fund shares. If too many investors see this and redeem their shares in a panic, then the fund has to sell bonds at a loss to meet redemptions, thus actualizing the loss. Does the safety of these funds depend on the stability of your fellow fund owners?! It makes individual bond ownership seem safer - no one can force you to sell early and actualizing your loss.


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[pb4uski]

But it is an ETF, not a fund so they have no obligation to provide liquidity for investors who want out and as a result would have no need to sell bonds... people who want out would need to find a buyer in the open market.

Besides, I think that most people who have invested in these are likely to be fairly sophisticated investors who will understand the need to just ride it out until the terminal distribution is paid.

[haha]

Quote:

Originally Posted by pb4uski But it is an ETF, not a fund so they have no obligation to provide liquidity for investors who want out and as a result would have no need to sell bonds... people who want out would need to find a buyer in the open market. Besides, I think that most people who have invested in these are likely to be fairly sophisticated investors who will understand the need to just ride it out until the terminal distribution is paid.

An ETF is not a closed end fund. It is open ended, so while a typical small investor cannot redeem in kind, large investors can and they are looking for arbitrage profits. This is why the NAV of an ETF varies but little from it's market price, unlike a closed end fund which can vary a lot, because the CEF arbitrage is more involved and takes capital and expenses, and requires the person or firm trying to get arbitrage profits to accept some risk.

Carl Icahn and others have recently pointed out the mismatch in liquidity and the resulting risk that the assumed market liquidity of an ETF, which may be mush greater than the liquidity of the underlying bonds, may present.

Ha

[mathjak107]

Quote:

Originally Posted by papadad111 As others have said. If you hold individual bonds and hold to maturity, the interest rate risk is irrelevant. As long as you don't need to sell at some point in the future and hold all bonds to maturity, the only thing u may see is a portfolio marked to market ( statement value) that is a lot lower than the future maturity value (due to and assuming a rise in interest rates)

except you still lose with individual bonds . as an example getting your 1k back on a 30 year bond 30 years later may buy less than 1/2 of what it did , maybe even less .

so while your interest rate and principal amount stays steady your principal amount takes a loss in purchasing power .

so whether you lose it in share price or you lose it in purchasing power , take your pick , you are behind either way .

[Totoro]

Quote:

Originally Posted by luckyiknow To clarify, I own individual municipal bond issues. When I get a statement, it shows the total value of my holdings which I assume is based on market. If so I usually ignore it because I assume the bonds will be held to maturity.

It's safe to ignore from a yield perspective in a 'business as usual' scenario.

The value however does tell you important things.

For one, what the interest rates are doing elsewhere and whether you have a good deal, or a not so good deal relative to that. If the value drops it means for you that you'll likely be able to get better interest rates elsewhere. Conversely, higher values mean you made a great call and interest rates are dropping.

Another second one, which is more important arguably, is that a lower value can indicate an increased bankruptcy risk.

To illustrate a popular example: Puerto Rico and Greek bonds plummeted because many investors thought they would default. And they did.

[Chuckanut]

Don't some if not many bond fund also trade their bonds to take advantage of increases in price, and to alter the duration so as to prevent a catastrophic loss?

[NW-Bound]

Maybe they already do, thereby pushing the 3-yr Treasury down to 1%, while the average inflation of the last 10 years is 2%. The 10-yr Treasury barely covers that inflation. There's no place to hide.

[audreyh1]

Quote:

Originally Posted by Chuckanut Don't some if not many bond fund also trade their bonds to take advantage of increases in price, and to alter the duration so as to prevent a catastrophic loss?

Bond funds are continually trading bonds. They do this to maintain their duration, trading shorter maturities for longer ones as they age - they don't usually wait for a bond to mature. They also trade bonds that have appreciated for ones they think have better value. They move up and down the yield curve within their duration goal to where they find better value.

[pb4uski]

Quote:

Originally Posted by haha An ETF is not a closed end fund. It is open ended, so while a typical small investor cannot redeem in kind, large investors can and they are looking for arbitrage profits. This is why the NAV of an ETF varies but little from it's market price, unlike a closed end fund which can vary a lot, because the CEF arbitrage is more involved and takes capital and expenses, and requires the person or firm trying to get arbitrage profits to accept some risk.....

I'm aware of that... but was responding to his question of what would happen if a bunch of (retail) investors wanted to cash out.

Also, as I understand it, a fund is not required to do these in-kind trades that you refer to and can refuse if they deem it to not be in the best interest of the fund... correct?