What Affects Bond Prices & Yields?
Fidelity Investments
Just like other investments, prices of bonds and bond funds can fluctuate. The possibility that
an investment could lose value is often referred to as risk. Every investment has some element of risk,
although bonds are usually considered one of the less volatile investments.
Investments in bonds and bond funds do carry risk. Four types of risk are:
Interest-rate risk
If interest rates rise and bond (and bond fund) prices fall this will lower the value of your investment. All types of bond funds
are subject to interest-rate risk, but you can moderate it to some degree by choosing a bond fund with a shorter duration or
average maturity. Generally, the longer a fund's duration or average maturity, the higher its interest-rate risk, or the more
sensitive its share price will be to changes in interest rates. Fidelity's bond fund investment team employs a duration-neutral
strategy so that each bond fund's duration is close to the fund's benchmark. This strategy takes the "guess-work" out of trying to
predict the direction of interest rates and helps to reduce interest-rate risk in our funds.
Credit risk
Bonds carry the risk of default, meaning that the issuer is unable to make further payments on it. Bond funds offer professional
management and a range of quality ratings to help lower this risk. Credit risk is a greater concern if the fund invests in
lower-quality bonds. These "junk bond" funds tend to be more sensitive to the health of the economy and health of the particular
issuers rather than to interest rates. Fidelity offers taxable and municipal bond funds which invest exclusively in high-quality
bonds that are rated investment grade by outside rating agencies, further reducing their exposure to credit risk.
Prepayment risk
A bond issuer may decide to pay off the principal of an existing bond before it matures. This risk is a particular concern with mortgage-backed bonds such as Ginnie Maes. During periods
when interest rates are low and many mortgage-backed bonds are being prepaid--because homeowners are refinancing--it is possible for both the yield and the share price of a
mortgage-backed bond fund to decline within a short period of time. This is because the fund must reinvest its assets at the prevailing rate, which is generally lower during times when
widespread prepayments are occurring. This potential risk is what allows Ginnie Maes to provide higher yields than U.S. Treasuries. To help lessen prepayment risk, Fidelity's research
capabilities are unparalleled. Fidelity's 32 credit analysts and 6 quantitative analysts conduct extensive research to thoroughly evaluate the bonds and underlying issuers we purchase for our funds.
Balancing risk vs. reward
As with any type of investment, there is a trade-off between the risk you are willing to assume and the potential return you will get. The greater the risk of a bond fund, the higher the potential
reward, or return. With a bond fund, one of the risks is that prices may fluctuate and the value of your investment may increase or decrease.
There is a range of risks associated with bond funds with short-term bonds fund carrying the least risk and global funds carrying the highest
risk. Create a portfolio that allows you to manage risk by matching it to your risk tolerance and time horizon.
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