Climbing the Ladder: How to Manage Risk in Your Bond Portfolio
Interest rates fluctuated widely throughout the year, then rose dramatically by the end of that year. This caused the bond market to lose significant value.
Why?
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When interest rates rise, market values of existing bonds drop because their interest rates are fixed and the present value of the bond's stream of interest payments fluctuates. These factors caused investors to panic and sell their bond funds, leaving fund managers with no choice but to sell these long-term bonds at depressed prices as a way to generate cash for redemptions.
THE RISKS
The 1987 bond market crash dramatically illustrates the market price risk of fixed bonds and bond funds. However, there are actually four main risks inherent in every bond and bond fund:
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