The Lesser-Known Risks of Bond Investing

In the area of bond investing, there are several risks that investors are subject to. Many investors are familiar with interest rate risk and default risk, but may overlook some of the lesser-known risks that are present in this market. There are other risks such as downgrade risk and rip-off risk that an investor should have some knowledge up before getting involved in the market. Here are some of the different risks that are associated with bond investing.

Downgrade Risk

Downgrade risk is a risk that many investors are completely unaware of but it can have a drastic effect on the value of your bonds. Bonds are regularly rated by financial publications such as MorningStar or Standard & Poor's. These bond ratings are critically important to investors in this market. The ratings that are released are directly correlated to the level of risk that is associated with investing in each bond. If a company is at risk of default, it will be awarded a lower bond rating than a company that is not at risk. Even though a bond might have a high rating when you initially invest in it, that does not mean that the rating could never change. If you invest in a financially stable company and the company goes through some financial problems, the financial publications could decide to downgrade the rating of the bond. Downgrading a bond rating will generally have a drastic effect on the value of the bond. Investors will be more skeptical about investing in this type of bond because there is a risk of default present.

Rip-Off Risk

Rip-off risk is another type of risk that you need to be aware of in the bond market. When you deal with bonds in the secondary market, you are essentially working with another individual investor. There is always the chance that they could try to take advantage of you when you are buying or selling a bond. Because there is no centralized exchange, there is no governing body that watches over all of the transactions that are taking place. This increases the amount of rip-off risk that is present.

Call Risk

Another type of risk that you need to be aware of is call risk. Call risk is a type of risk that is associated with the bond issuer paying you back early. Instead of getting interest payments for the next 30 years like you thought, you will only get your principal amount back. Many bonds that are issued by various entities are callable and can be repaid at any point. This gives the investor a level of uncertainty when it comes to counting on interest rates.

Liquidity Risk

Liquidity risk is another type of risk that may impact the value of your bonds. If you go to sell your bonds in the secondary market, you have to be able to find a buyer for the transaction to work. If you cannot find several willing buyers, you may have to sell your bond at a discount in order to attract an investor.

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