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4 BOND INVESTMENT MANAGEMENT Let’s recap what we know—and what we don’t. Given the parameters of a bond—coupon, maturity, and so on—we know what the bond pays. Given what the bond pays, plus knowledge of how much the mar- ket requires that it pay—its yield—we can calculate, using the tools of Chapter 3, what the bond is worth, or its price. How does the market go about deciding how much the bond should yield? The foundations for interest rates are determined by the macroeconomy, explained in the following two chapters (with exten- sions in Chapter 8, “The Yield Curve,” and in Chapter 9 “Corporate Bonds,” on the risk premium in corporate bonds: What we need to learn now is what to do with the bond once we know its yield, hence its price. In other words, how do we employ it in a portfolio? Rate of Return First we need to make clear what kind of portfolio manager we are deal- ing with. We’re not talking about a speculator (you might use the word “trader” as a substitute in this context). By speculator I mean a bond market participant who would purchase a bond solely for the expecta- tion that a price rise is imminent (or who would sell short in anticipa- tion of an imminent price decline). We’re also not talking about a bond dealer, whose intention is to hold the bond only temporarily until a buyer is found. Rather, the focus is on an investor. In this context, 35 36 • Fundamental Principles of Bond Structure, Pricing, and Investing investor refers to a portfolio manager interested in the regular income a bond produces, in addition to any possible price appreciation. As such, this investor has a longer time horizon than the speculator for holding the security. Let’s start by looking at Figure 4.1. In Chapte