Bonds: income is only one part of the risk

Read the promise and the price separately

A conventional fixed-rate bond is a loan with stated interest payments and a repayment date. The coupon is calculated from its face value. The price you pay in the market may be above or below that value, so the coupon percentage is not the same thing as the return available at today’s price.

Yield to maturity combines the price and scheduled payments under specific assumptions. It is an estimate based on the issuer paying as promised, and the calculation has reinvestment assumptions. Check whether a quoted figure is a running yield, yield to maturity or something else before comparing two products.

Duration describes sensitivity

For an ordinary fixed-rate bond, a rise in market yields generally reduces the present value of its payments. Modified duration estimates the percentage price change for a small change in yield, with other factors held constant. It is a sensitivity measure, not the number of years until repayment.

As a rough illustration, modified duration of six implies about a 6% price decline if the relevant yield rises by one percentage point. The approximation becomes less reliable for larger moves. Yield-curve changes, embedded options and convexity can alter the result.

Keep credit and currency in view

Duration does not tell you whether the borrower can pay. Read the issuer, ranking, currency and any call terms. A lower-quality bond may fall when its credit spread rises even if government yields are steady. A foreign-currency payment also has an exchange-rate value in your home currency.

An individual bond and an ordinary bond fund have different structures. A fund continually changes its holdings and generally has no single date on which your purchase price is repaid. A low-duration label does not turn either structure into a bank deposit.

Make comparisons consistent

Compare figures from the same date and in the same currency. For a fund, note its duration, credit-quality mix, fees and distribution policy. A recent distribution is not a promise about the next one, and a trailing yield can describe a different period from the one you intend to hold.

• What could change the price before I need the money?
• Which figure represents income, and which includes a market-price assumption?
• What happens if rates, credit spreads or currency move against this holding?