FYI Helping Investors to Select Desired Interest-Rate Risk
Because many investors want to know how much interest-rate risk they are exposed to, some mutual fund companies try to educate investors about the perils of interest-rate risk, as well as to offer investment alternatives that match their investors preferences.
For example, one U.S. company, Vanguard Group, offers eight separate high-grade bond mutual funds. In its prospectus, Vanguard separates the funds by the average maturity of the bonds they hold and demonstrates the effect of interest-rate changes by computing the percentage change in bond value resulting from a 1% increase and decrease in interest rates. Three of the bond funds invest in bonds with average maturities of one to three years, which Vanguard rates as having the lowest interestrate risk. Three other funds hold bonds with average maturities of five to ten years, which Vanguard rates as having medium interest-rate risk. Two funds hold long-term bonds with maturities of 15 to 30 years, which Vanguard rates as having high interest-rate risk.
By providing this information, Vanguard hopes to increase its market share in the sale of bond funds. Not surprisingly, Vanguard is one of the most successful mutual fund companies in the business.
APPLICATION Calculating Real Interest Rates
What is the real interest rate if the nominal interest rate is 8% and the expected inflation rate is 10% over the course of a year?