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Obviously the bonds will loose value if the issuer defaults, but if there is a stable, predictable number of defaults in the funds bond holdings, how does a bond fund fall in value? I know that the face value of the given bonds will move in the opposite direction of the interest rate. But would it not be the case that this decrease in value will only be realized if the bond is sold/traded before maturity, and so, if one simply continue to hold the bond until maturity, you should continue to receive the fixed interest...

  • A better title would be "Will a bond have reduced value at maturity except in the case of default". You are already aware of most effect before maturity. – base64 Sep 6 '16 at 14:07
  • @base64 Right... I am asking due to a general concern that the stock market (particularly tech stocks) are starting to get overpriced, and so i am looking to place my money possibly in bonds (a bond fund that is, since getting hold of corporate bonds seam difficult without very large sums of money) but then again, I am also expecting interest rates to start increasing the near future, and so, bonds can seam tricky too... And so i want to know the risks related to increasing interest rate and bond fund values. – Daniel Valland Sep 6 '16 at 14:17
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    Bond Fund does not have maturity. Money from the bonds in the bond fund will be used to buy more bonds that are yet to mature. – base64 Sep 6 '16 at 14:23
  • @base64 Right, but am i correct to assume that the only ways a bond fund could decrease in value over time is if there is either an increase in defaulted bonds in the funds holdings, or the fund is selling off bonds before maturity at a lower value than when they were bought? – Daniel Valland Sep 6 '16 at 14:30
  • No, you are missing how bond funds have to be priced daily and thus the decline in value has to show up. Look at the Vanguard Long-term US Treasury bond fund(VUSTX) that had a -13% return in 2013 as an example of the short-term loss that can happen in a bond fund. – JB King Sep 6 '16 at 18:08
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Because you are mixing the bond value with the fund value.

The fund will have a mix of assets, for a "bond fund", it will be almost all of them bonds (see the specifics for each fund on what securities it can invest on).

As pointed out by Tom's answer, The risk inherent to interest rate fluctiations can change the value of the bonds, because of opportunity costs of holding the bond.

The fund value can also fluctuate due to external factors not related to the bonds, for example withdrawals. If there are several big withdrawals from the fund, and the fund does not have available cash to pay for those withdrawals, then it will have to sell some securities/bonds to cover those withdrawals. This can happen at a sub-optimal time, and the fund value can drop more than the underlying bonds.

  • @DanielValland: What Maindwin said is true for "closed end" bond funds, but not for "open end" funds. – Tom Au Sep 6 '16 at 16:58
  • This leaves out the most important factor: when interest rates go up bond values go down, and vice versa. See the answer by @TomAu. – Pete Becker Sep 6 '16 at 17:17
  • @TomAu I'm not sure which you disagree with. Closed-end fund don't have to sell holdings on a dip, but if shares trade the price will reflect current valuation of the holdings, because they compete in the market. Open-end traditional funds do price NAV at every market close, and open-end ETFs are driven very close to NAV by arbitragers. – dave_thompson_085 Sep 8 '16 at 9:53
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Bond funds go up and down depending on whether the underlying bonds go up or down in value. One reason that bonds may go down is, as you said, the risk of default.

Besides defaults, the other main risk is interest rate risk. Bonds pay interest rates prevailing on the day that they were issued. If interest rates suddenly go up, the bonds have to go down enough so that their "old" rates yield as much interest as the "new" rates. That, and not default risk, is the main reason that bond funds go down.

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Well, the bond funds are "marking to market" when they figure out the net asset value of the fund. As interest rates rise, the market value of the bond drops and the NAV falls to match this.

Funds that hold mostly long term bonds feel this a lot more than funds that hold short term bonds. If you want a more stable fund value, you need to go to short duration funds that invest in bonds that come due in a few months. The price for this is that the return on short term funds is lower.

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