Many managed funds and super funds that invest in fixed interest, access fixed interest bonds on the secondary market. Therefore, the return on these bonds will depend on the price paid for them in the secondary market. This is best illustrated in the example below.
Let’s say, you invested $10,000 in a government bond for 12 months at 3% coupon rate.
If you hold the bond for 12 months you will receive $10,300.
After you invested in your bond, the market interest rate dropped to 1% for new bonds issued now with the same features.
In this case the capital value of your bond will increase as you are getting 2% more income on your bond than other investors would get if they were to buy a new bond.
Therefore your bond becomes more attractive to buyers and this is reflected by a higher price for your bond compared to the amount you paid for it.
You could now sell your bond to someone else for more than $10,000 you paid, thereby making a capital gain.