Bond Basics: An Investor's Guide to the Many Meanings of Yield
Let us assume that you are reading the financial pages of your favorite newspaper. You read that even though stock returns have been dismal for the last two years, bond returns have been very good. In fact, you read that over the past two years, many bond funds returned well over 15%. While the returns look pretty darn good relative to stocks, you may wonder: Does that mean I can expect to earn 15% next year if I buy bonds? If the answer is not obvious, read on.
The direction of interest rates is one of the chief determinants of bond prices. A strong market for bonds is one in which interest rates are declining. That causes bond prices to go up. A weak bond market is one in which interest rates are going up. That causes bond prices to decline. Clearly, then, since changes in interest rate levels affect bond prices, they also affect what you earn from investments in bonds.
But that is only the beginning. In order to understand what you actually earn from bonds, you need to understand two different concepts: yield and total return.
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