Bonds: the Other View. Essay

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For the casual observer, bond investing would appear to be as simple as buying the bond with the highest yield. While this works well when shopping for a certificate of deposit (CD) at the local bank, it's not that simple in the real world. There are multiple options available when it comes to structuring a bond portfolio, and each strategy comes with its own tradeoffs. The four principal strategies used to manage bond portfolios are: a) Passive, or "buy and hold" b) Index matching, or "quasi passive" c) Immunization, or "quasi active" d) Dedicated and active Passive Bond Strategy The passive buy-and-hold investor is typically looking to maximize the income generating properties of bonds. The premise of this strategy is that bonds are assumed to be safe, predictable sources of income. Buy and hold involves purchasing individual bonds and holding them to maturity. Cash flow from the bonds can be used to fund external income needs or can be reinvested in the portfolio into other bonds or other asset classes. In a passive strategy, there are no assumptions made as to the direction of future interest rates and any changes in the current value of the bond due to shifts in the yield are not important. The bond may be originally purchased at a premium or a discount, while assuming that full par will be received upon maturity. The only variation in total return from the actual coupon yield is the reinvestment of the coupons as they occur. On the surface, this may appear to be a lazy style of investing, but in reality passive bond portfolios provide stable anchors in rough financial storms. They minimize or eliminate transaction costs, and if originally implemented during a period of relatively high interest rates, they have a decent chance of outperforming active strategies. One of the main reasons for their stability is the fact that passive strategies work best

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