For a fixed rate bond purchased at par, there are three sources of return:
If a bond is purchased at a discount or premium, the rate of return also includes the effect of the price being “pulled to par” as we approach maturity. Total return of a bond = reinvested coupon interest payments + sale/redemption of principal at maturity.
Changes in interest rate affect the realized rate of return for any bond investor in two ways:
Market price risk dominates coupon reinvestment risk when the investor has a short-term horizon. Coupon reinvestment risk dominates market price risk when the investor has a long-term horizon: for instance, a buy-and-hold investor.
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