Question

In general, bonds are considered safer investment than stock. What type of risk do bond holders face? Please explain.

Answer 1

Types of risks that bondholders face-

1) Interest rate risk - Increase in interest rate leads go fall in prices which increases investor's return. On the other hand, falling interest rate will create an opposite position for the investor

2 )Inflation risk - Inflation reduces the purchasing power of bond's future principal and coupon payments

3)Credit risk - this is the risk associated with the bond issuer's ability to pay the coupon payments and Principal back to the investor

4) Reinvestment risk - when interest rate falls, investors might have to invest their coupon amount and Principal at a lower interest rate.

5) Liquidity risk- This risk is associated with finding a buyer in case the investor wants to sell the bond and he may have to sell the bond at significant discount.