By David Merkel of AlephBlog.com
I received the following from a reader:
My primary motivation for writing to you is this post by Jeff Miller.
In my mind, you are the foremost expert blogger when it comes to bonds so I wanted to get your take. It’s been a long time since my bond class getting my MBA and I haven’t dealt with bond math in quite awhile.
I’m wondering about this whole individual bond ladder versus bond fund issue. Maybe I am wrong so I wanted to ask you. Duration is duration. Whether one owns an individual bond ladder or a bond fund, if the duration is the same, the price sensitivity to an increase in interest rates is the same? If a person owns an individual bond ladder and rates move up, those bonds will be marked to market and show a capital loss even if they pay off at par at maturity, and you’ve locked in your cashflow. With a bond fund, you take a price hit to the fund, but those cashflows from the fund get reinvested in the fund at lower prices and higher yields?
I guess I am just wondering if someone is going to buy and hold and sit tight for say 5-7 years whether they construct a bond ladder or buy a bond fund if the duration is the same, they are going to end up pretty much in the same place 5 years later.
Anyways, I hope maybe you will do a post on the ins and outs of bond math vis a vis interest rate changes and the pros and cons of bond funds versus a bond ladder from the perspective of duration. Thanks.
From 1995-2001, I spent a lot of time doing interest rate modeling. With the growth in computer power and modeling techniques, we finally hit the barrier …
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