Reply to bond funds - explain to me how they will decline with rising interest rates

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Reply to "bond funds - explain to me how they will decline with rising interest rates"

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[quote=Anonymous]You have to understand the difference between individual bonds and bond funds. You also have to take into account opportunity cost.

Funds generally come in three different flavours- Short term, Long term and Intermediate, determined by when bonds held by that fund are due to mature. Right now long term bond funds have good returns because of the general low interest rate environment. However, once interest rates start to rise, the long term funds will be locked into a 3% interest rate that no longer looks  so hot  when 5-8% rates are out there and inflation is creeping up.

This is where opportunity costs come into play. Say you own an individual bond you bought for $100, returning $3 a year in interest and set to mature in 30 years. Interest rates rise. Now you  find you own a bond with 25 years till maturity, yet on the market new $100 30 year bonds are returning $10 a year!

Now the question becomes, at what price would you sell your original bond in order to invest at the higher interest rate?[/quote]

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