Bonds can be a great tool to generate income and are widely considered to be a safe investment, especially compared with stocks. However, investors should be aware of the potential pitfalls of holding corporate bonds and 澳洲幸运5开奖号码历史查询:government bonds. Below, we'll discuss the 🍌risks that co꧅uld impact your hard-earned returns.

1. Interest Rate Risk and Bond Prices

The first thing a bond buyer should understand is the inverse relationship 澳洲幸运5开奖号码历史查询:between interes♕t 🐼rates and bond prices. As interest rates fall, bond prices rise. Conversely, when interest rates rise, bond prices tend to fall.

This happens because when interest rates are on the decline, investors try to capture or lock in the highest rates they can for as long as they can. To do this, they will scoop up existing bonds that pay a high꧑er interest rate than the prevailing market rate. This increase in demand translates into an increase in bond prices.

On the flꩵip side, if the prevailing interest rate is on the rise, investorಌs would naturally jettison bonds that pay lower interest rates. This would force bond prices down.

Let's look at an example. An investor owns a bond that trades at 澳洲幸运5开奖号码历史查询:par value and carries a 4% yield. Suppose the prevailing market interest rate rises to 5%. What will happen? Investors will want to sell the 4% bonds in favor of bonds that return 5%, which will, in turn, send the price of the 4% bonds 澳洲幸运5开奖号码历史查询:below par. In bond terminology, duration measures the sensitivity of the price of a bond to a change in interest rates. If interest rates rise,♔ bond prices will fall, and the duration tells you by how much given a 1% change in rates.

2. Reinvestment Risk and Callable Bonds

Another danger bond investors face is 澳洲幸运5开奖号码历史查询:reinvestment risk, which is the risk of having to reinvest proceeds at a lower rate than what the funds were previously earning. One of the main ways this risk presents itself is when interest rates fall over time and 澳洲幸运5开奖号码历史查询:callable bonds are exercised by the issuers.

The 澳洲幸运5开奖号码历史查询:callable feature allows the issuer to redeem the bond prior to maturity. As a result, the 澳洲幸运5开奖号码历史查询:bondholder receives the principal payment, which is often at a slight premium to the par value.

However, the downside to a bond call is the investor is then left🃏 with a pile 🐼of cash they might not be able to reinvest at a comparable rate. This reinvestment risk can adversely impact investment returns over time.

To compensate for this risk, investors receive a higher yield on the bond than they would on a similar bond that isn't callable. Active bond investors can attempt to mitigate reinvestment risk in their portfolios by staggering the potential 澳洲幸运5开奖号码历史查询:call dates of differing bon🦄ds. This limits the chance that many bonds will be called at once.

3. Inflation Risk

When an investor buys a bond, they essentially commit to receiving a 澳洲幸运5开奖号码历史查询:rate of return, either fixed or variable, for the time that the bond is held. And what happens if the 澳洲幸运5开奖号码历史查询:cost of living and 澳洲幸运5开奖号码历史查询:inflation increase dramatically, and at a faster rate than income investment? When this happens, investors will see their 澳洲幸运5开奖号码历史查询:purchasing power erode, and they may actually achieve 澳洲幸运5开奖号码历史查询:a negative rate of return when factoring in inflation.

Put another way, suppose an investor earns a 3% rate of return on a bond. If inflation grows at 4% after the bond purchase, the investor's true rate of return is -1% because of the decrease in purchasing power.

4. Credit/Default Risk

When an investor purchases a bond, they are actually purchasing a certificate of debt. Simply put, this is borrowed money the company must repay over time with interest. Many investors don't realize that 澳洲幸运5开奖号码历史查询:corporate bonds aren't guaranteed by the 澳洲幸运5开奖号码历史查询:full faith and credit of the U.S. government but instead depend on the issuer's 澳洲幸运5开奖号码历史查询:ability to repay that debt.

Investors must consider the possibility of default and factor this risk into their investment decision. As one means of analyzing the possibility of default, some analysts and investors will determine a company's 澳洲幸运5开奖号码历史查询:coverage ratio before initiating an investment. They will analyze the company's income and cash flow statements, determine its operating income and cash flow, and then weigh that against its 澳洲幸运5开奖号码历史查询:debt service expense. The theory is the greater the coverage (or operating income and cash flo🦩w) in proportion to the debt service expenses, the safer the investment.

5. Rating Downgrades

A company's ability to operate and repay its debt issues is frequently evaluated by major rating institutions such as 澳洲幸运5开奖号码历史查询:Standard & Poor's 𓂃Ratings Services or 澳洲幸运5开奖号码历史查询:Moody's Investors Service. Ratings range from AAA for high 澳洲幸运5开奖号码历史查询:credit quality investments to D for bonds in default. The decisions made and judgments passed by these agencies carry a lot of 🏅weight on investors.

If an issuer's 澳洲幸运5开奖号码历史查询:corporate credit rating is low or its ability to operate and repay is questioned, banks and lending institutions will take notice and may charge a higher interest rate for future loans. This can adversely impact the company's ability to satisfy its debts and hurt existing bondholders who might have been looking to unload their positions.

6. Liquidity Risk

While there is almost always a ready market for government bonds, corporate bonds are sometimes entirely different animals. There is a risk an investor might not be able to sell their corporate bonds quickly due to a 澳洲幸运5开奖号码历史查询:thin market with few buyers and sellers for the bond.

Low buying interest in a particular bond issue can lead to substantial price volatility and adversely impact a bondholder's 澳洲幸运5开奖号码历史查询:total return upon sale. Much like stocks that trade in a thiཧn market, you may be for♉ced to take a far lower price than expected when selling your position in the bond.