Types of Bonds
Bond and Bond Funds
Risks of Bond Investing
- Interest rate risk: when interest rates rise, bond prices fall. If you need money and have to sell your bond before maturity in a higher rate environment, you will probably get less than you paid for it. Interest rate risk declines as the maturity date gets closer. Learn more about bond yields.
- Credit risk: if the issuer--or the assets backing the issuer--runs into financial difficulty or declares bankruptcy, it could default on its obligation to pay the bondholders.
- Liquidity risk: if the bond issuer’s credit rating falls or prevailing interest rates are much higher than the coupon rate, it may be hard for an investor who wants to sell before maturity to find a buyer at least at a good price. Bonds are generally more liquid during the initial period after issuance as that is when the largest volume of trading in that bond generally occurs.
- Call risk or reinvestment risk: If a bond is callable, the issuer can redeem it prior to maturity, on defined dates for defined prices. Bonds are usually called when interest rates are falling, leaving the investor to reinvest the proceeds at lower rates. This also occurs with certain types of mortgage backed securities.
- Currency exchange risk: Currencies - the Euro, pound sterling, the dollar, the yen, etc. - move in relationship to one another. If you have investments in other currencies than your own, the risk is that the currency your bond is in will appreciate. When the bond’s proceeds are converted back into your own currency, the proceeds will be worth less.
- Sovereign risk: The risk that the government issuing the bond will act in ways that negatively affect the value of the bond.
- Event risk: The risk that an unpredictable, unforeseen event will downgrade a bond’s credit rating.
- Inflation risk: Inflation risk is the risk that inflation will require you to need more money in the future to buy the same things you buy now. Therefore, when investing, you need to beat the rate of inflation.