I believe I understand the effect of interest rates on bonds. But two questions come to mind. First, if you own individual bonds would you be better off keeping the bonds to maturity and getting the maturity value of the bonds, but losing out on higher rates; or should you sell and reinvest at some point in higher-interest-rate bonds? Second, does this change with bond mutual funds — do fund managers hold bonds to maturity, or do they generally sell and reinvest when interest rates are going up? — J.T., Austin
On highly liquid and secure securities such as Treasuries, the market adjusts the price of the bonds so that the discounted present value of an older, lower-coupon obligation would be identical to the discounted present value of a new bond with a higher coupon. Some of the damage done to lower-coupon bonds in a rising-rate market is reduced by reinvestment of the coupons at the new higher rates. You can learn the basics of all this in the classic “Inside the Yield Book” by Sidney Homer and Martin Liebowitz, first published in 1972. As for fund managers, it varies; there is no standard practice.
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