
To address inflation risk, the U.S. treasury introduced a new type of bond 
in 1997 - the Treasury inflation-indexed security. The interest rate paid by 
the bond will remain constant during the life of the bond, but the principal 
will be adjusted semiannually to reflect inflation. In periods of rising prices, 
the principal of a Treasury inflation-indexed security will increase. This 
means that the interest payments will also rise because they are based on a 
larger principal amount. As a result, the buying power of the interest payments 
and the principal should remain steady even during periods of rapid inflation. 

Of course, prices don't always rise. In a period of deflation (in other words, 
a time of falling prices), the principal amount of a Treasury inflation-indexed
security might be reduced. However, when the principal amount is repaid at
maturity, the investor will receive the larger of the inflation-adjusted principal 
or the face amount even if deflation had reduced the adjusted principal amount 
to a sum that is less than the security's face amount.

If this new type of bond is well received by investors, the U.S. Treasury plans 
to offer them in a variety of maturities. Today, there are a few mutual funds 
that specialize in these inflation-indexed bonds.
 
Many funds are actively managed, meaning that the investment adviser uses economic, 
financial, and market analyses when deciding which bonds to buy or sell. Manager 
risk refers to the possibility that the investment adviser may fail to choose an 
effective investment strategy or to execute that strategy well. As a result, an 
investor in the fund may lose money. Some managers limit their investments to issues 
rated Baa or higher by Moody's Investors. Despite the relatively low credit risk 
of investment-grade corporate bond funds, they do not match the quality level of 
U.S. government bond funds. As a result, corporate bond funds generally pay higher 
yields than U.S. government bond funds.

Some bond funds also may be exposed to event risk, the possibility that some 
corporate bonds may suffer a substantial decline in credit quality and market 
value because of a corporate restructuring for example, a merger, leveraged 
buyout, or takeover. Restructurings are sometimes financed by a significant 
increase in the company's debt an added burden that could hurt the credit quality 
of the company's existing bonds. Still more risks can arise from the use of 
derivatives, such as futures or options, whose values are linked to (or derived 
from) the value of another asset or commodity. Because different derivative-trading
strategies carry different amounts of potential risk and reward, some funds 
limit the use of derivatives by their portfolio managers.
