Common Bond Risks


Bonds are essentially an agreement written in paper that companies sell indicating that it borrowed a certain amount from the bearer and that the amount is payable at a certain period of time, with interest. In essence, bonds are IOU’s that companies offer in order to gather added capital or funds to keep the business running or to fund some much needed expansion or development. ItHere are the common ones.

Inflation Risk

Since bonds are considered as fixed income investments, it is liable against inflation risk. Since what a bond comes with a fixed rate of return for a certain period of time, its purchasing power may diminish in case the inflation rate is higher during maturity than when it was issued. In a way, the bond investor may lose money in terms of its purchasing value with an increase in inflation rates.

Interest Rate Risk

The effect on the interest rates is in inverse proportion to bond prices. When the interest rates rise, the bond price goes down. When interest rates go down, bond prices go up. The reason behind this is because when the interest rate goes down, bond investors would like to lock into the highest rates they can for as long as they can. This means that investors try to get as many of the bonds with higher interest rates that are above the prevailing market rate. This will instill demand and will lead to an increase in bond prices. On the other hand, an increase in interest rates will lead to investors getting rid of more bonds that pay low interest rates. This drives down bond prices in the process.

Liquidity Risk

Most of the bonds that are bought and sold in the market are government bonds. Corporate bonds are another matter. Investors in such bonds may be into some risk in terms of liquidation. While government bonds always have a ready market, the corporate bonds do not. The thin market for them may make it hard for the investors to unload them from the portfolio when needed.
Investing – GuideTo.Com

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