Basics of Bond Funds

As a general matter, all bond funds seek to provide current income. Indeed,
over the long term, virtually all of the total return of bond funds comes in the
form of reinvested interest income, with a much smaller portion resulting from
capital growth. This capital component is primarily a function of interest rates. 
If interest rates go down, bond prices go up - resulting in a capital appreciation.
The reverse is also true: if interest rates go up, bond prices go down - resulting
in a capital loss.

The key determinant of a bond fund's sensitivity to interest rate changes is its
average weighted maturity, which takes into account the maturity level of each
individual bond held by the fund. The longer a bond fund's average maturity, the
greater the fluctuation in its net asset value in response to a change in interest
rates. In return for accepting this interest rate risk, bond fund investors generally
earn a higher income yield for each step out in length of maturity. So, bond funds 
may be particularly suited for investors who depend upon interest income to meet 
their monthly living expenses. Bond funds may be divided into three major average 
maturity segments:

1. Short-term - average maturity of one to five years. 
2. Intermediate-term - average maturity of five to 10 years. 
3. Long-term - average maturity of 10 to 30 years. 

In addition to these three maturity levels, bond funds also vary by investment
objective. There are four primary investment categories, as discussed in the
following sections.
