Exposing Vulnerabilities

While bonds generally have less volatility than equities they are capable of great movement when extreme events happen. Here are some of the risks involved with bonds.

Interest Rate Risk

The risk that the value of a bond will decrease as interest rates rise. When interest rates go up, the market value of existing bonds with lower coupon rates becomes less attractive, leading to a decrease in their price.

Credit Risk (Default Risk)

The risk that the issuer of the bond will default on its interest payments, principal repayment, or both. This can happen due to financial difficulties or bankruptcy.

Call Risk

The risk that a bond will be called, or redeemed by the issuer, before its maturity date. This usually happens when interest rates decline, and the issuer can refinance its debt at a lower cost. This can lead to reinvestment risk for the bondholder.

Inflation Risk

The risk that the purchasing power of the bond's interest and principal payments will be eroded over time due to inflation.

Liquidity Risk

The risk that an investor will not be able to sell the bond at a fair price in the secondary market due to a lack of buyers or market volatility.

Event Risk

The risk that unforeseen events, such as regulatory changes, natural disasters, or changes in the financial condition of the issuer, will negatively impact the value of the bond.

Foreign Exchange Risk

For bonds issued in foreign currencies, there is a risk that changes in exchange rates may negatively impact the bond's value when converted back into the investor's home currency.

Duration Risk

The risk that a bond's price sensitivity to changes in interest rates will increase as the bond's duration (a measure of the bond's interest rate risk) increases.