Investment bonds: what are the risks?

19May11

Investment bonds are one of the most common forms of investment as they are seen as safe. Though, what are the risks to investment bonds, we find out?

Every form that financial investments come in carries its own risk, whether it may seem the safest option or it is the biggest risk, it will never be fully and completely secure. So if we look at investment bonds, which are seen as quite a safe investment, what are the biggest risks involved?

The most obvious and well know risk with investment bonds is the interest rate risk. This means that when you buy an investment bond you have committed to a fixed return of investment until a certain date or time. However, should the interest rate rise after the bond has been purchased the bond will be worth less and its price on the market will fall. The bond will be traded at a discount to reflect this.

It can be hard to determine when buying a bond if the interest rates will rise or fall as interest rates depend on a number of factors such as demand, inflation, and the amount of money in the economy and government policy among others. So as you can see it is laden with risk and this is only one particular risk involved in investment bonds.

Reinvestment risk is another type of bond investment risk. This would happen if the percentage you receive from your investment fell with each reinvestment. This would in turn mean that with reach investment you would be getting less and thus is a risk.

Default is also a risk; this would happen if the bond payer was unable to pay the rate on the bond for a certain reason. Credit rating companies such as Standards& Poor give ratings to bonds so investors can gauge how much of a risk a bond seems to be. For example large countries with AAA credit ratings have a certain degree of autonomy with their dealings and are considered safe bets to return on your money. However, poorer economies have lower ratings, or junk status meaning it is possible if you invest with them they may default and you will lose your investment.

Inflation is another risk involved in the bonds game. Inflation becomes a threat when it is a higher rate than interest over the period of the investment. This has the worst effect on fixed bonds, which can find that they losing purchasing power or money. If a bond gave an investment rate of 5 per cent but inflation was 10 per cent, the bond would lose 5 per cent in the space of time as inflation is more and its purchasing power at the end of the period is less.

The Call Risk refers to Callable bonds; these bonds can be called back and retired by the issuer from the bond holder. This often happens after a drop in interest rates as now the issuer can call in the bond and re sell it for a lower interest rate and so a lower cost.

As can be seen there a numerous risks with investment bonds that have to be taken into account. Make sure to do your research and always be aware of the negatives just as much so as the positives, helpful banking will assist you.

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