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Many investors who want to reap the good returns
available in the corporate bond market buy shares in bond mutual funds
instead of individual bonds or in addition to individual bonds. They do so
for the same reasons investors have flocked to mutual funds of all kinds in
recent years diversification, professional management, modest minimum
investments, automatic dividend reinvestment and other convenience features.
Diversification is an especially important advantage of bond funds. Many
investors in individual bonds buy only a few securities, thus concentrating
their risk. A fund manager, by contrast, spreads credit risk, interest-rate
risk and, indeed, all other kinds of risk, over many bonds. Different
issuers, sectors, credit ratings, coupons and maturities are all represented
in a diversified portfolio.
However, lower risk does not mean no risk. All the underlying risks that
affect bonds affect bond funds but not as sharply. You should be aware that
prices of bond fund shares fluctuate inversely with interest rates, just as
individual bonds? prices do, and when you sell fund shares, they may be
worth more or less than you paid for them.
Remarks: Corporate bonds (also called corporates) are
debt obligations, or IOUs, issued by private and public corporations. They
are typically issued in multiples of $1,000 and/or $5,000. Companies use the
funds they raise from selling bonds for a variety of purposes, from building
facilities to purchasing equipment to expanding the business.
When you buy a bond, you are lending money to the corporation that issued
it. The corporation promises to return your money, or principal, on a
specified maturity date. Until that time, it also pays you a stated rate of
interest, usually semiannually. The interest payments you receive from
corporate bonds are taxable. Unlike stocks, bonds do not give you an
ownership interest in the issuing corporation.
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