Investing in bonds comes with various risks that investors should be aware of. Here are the primary risks associated with bond investments:
Definition: The risk that changes in interest rates will affect the market value of a bond.
Impact: When interest rates rise, the prices of existing bonds typically fall because new bonds are issued with higher yields. Conversely, when interest rates fall, the prices of existing bonds typically rise.
Definition: The risk that the bond issuer will be unable to make interest payments or repay the principal at maturity.
Impact: Bonds issued by entities with lower credit ratings have higher credit risk and thus offer higher yields to compensate investors for the increased risk of default.
Definition: The risk that inflation will erode the purchasing power of the bond's future interest payments and principal repayment.
Impact: Higher inflation reduces the real value of the bond's fixed interest payments, making them less attractive.
Definition: The risk that the proceeds from a bond (such as interest payments or principal repayment) will have to be reinvested at a lower interest rate than the original bond.
Impact: This is particularly relevant for callable bonds, where the issuer might redeem the bond before maturity if interest rates fall.
Definition: The risk that an investor will not be able to sell a bond quickly at a fair price.
Impact: Bonds that are not frequently traded may be harder to sell without taking a discount on the price.
Definition: The risk that the overall market conditions will affect the price of the bond.
Impact: Factors such as economic downturns, changes in investor sentiment, and geopolitical events can influence bond prices.
Definition: The risk that a bond issuer will redeem a callable bond before its maturity date.
Impact: If a bond is called when interest rates have fallen, investors may have to reinvest the principal at a lower interest rate, leading to lower income.
Definition: The risk associated with the sensitivity of a bond's price to changes in interest rates, related to the bond's duration.
Impact: Bonds with longer durations are more sensitive to interest rate changes, leading to greater price volatility.
Definition: The risk that exchange rate fluctuations will affect the value of bonds denominated in a foreign currency.
Impact: For bonds issued in a currency other than the investor's home currency, unfavorable currency movements can lead to losses.
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