The Leading Business Education Network for Doctors, Financial Advisors and Health Industry Consultants

By Dr. David Edward Marcinko MBA MEd CMP™

SPONSOR: http://www.MarcinkoAssociates.com

***

***

Here are some of the most common risks associated with fixed income securities.

Interest Rate Risk

The market value of the securities will be inversely affected by movements in interest rates. When rates rise, market prices of existing debt securities fall as these securities become less attractive to investors when compared to higher coupon new issues. As prices decline, bonds become cheaper so the overall return, when taking into account the discount, can compete with newly issued bonds at higher yields. When interest rates fall, market prices on existing fixed income securities tend to rise because these bonds become more attractive when compared to the newly issued bonds priced at lower rates. 

Price Risk

Investors who need access to their principal prior to maturity have to rely on the secondary market to sell their securities. The price received may be more or less than the original purchase price and may depend, in general, on the level of interest rates, time to term, credit quality of the issuer and liquidity.

Among other reasons, prices may also be affected by current market conditions, or by the size of the trade (prices may be different for 10 bonds versus 1,000 bonds), etc. It is important to note that selling a security prior to maturity may affect actual yield received, which may be different than the yield at which the bond was originally purchased. This is because the initially quoted yield assumed holding the bond to term. As mentioned above, there is an inverse relationship between interest rates and bond prices. Therefore, when interest rates decline, bond prices increase, and when interest rates increase, bond prices decline.

Generally, longer maturity bonds will be more sensitive to interest rate changes. Dollar for dollar, a long-term bond should go up or down in value more than a short-term bond for the same change in yield. Price risk can be determined through a statistic called duration, which is featured at the end of the fixed income section.

REVENUE BONDS: https://medicalexecutivepost.com/2024/12/20/bonds-revenue/

***

***

Liquidity Risk

Liquidity risk is the risk that an investor will be unable to sell securities due to a lack of demand from potential buyers, sell them at a substantial loss and/or incur substantial transaction costs in the sale process. Broker/dealers, although not obligated to do so, may provide secondary markets.

Reinvestment Risk

Downward trends in interest rates also create reinvestment risk, or the risk that the income and/or principal repayments will have to be invested at lower rates. Reinvestment risk is an important consideration for investors in callable securities. Some bonds may be issued with a call feature that allows the issuer to call, or repay, bonds prior to maturity. This generally happens if the market rates fall low enough for the issuer to save money by repaying existing higher coupon bonds and issuing new ones at lower rates. Investors will stop receiving the coupon payments if the bonds are called. Generally, callable fixed income securities will not appreciate in value as much as comparable non-callable securities.

ZERO COUPON BONDS: https://medicalexecutivepost.com/2024/11/12/bonds-zero-coupon/

Prepayment Risk

Similar to call risk, prepayment risk is the risk that the issuer may repay bonds prior to maturity. This type of risk is generally associated with mortgage-backed securities. Homeowners tend to prepay their mortgages at times that are advantageous to their needs, which may be in conflict with the holders of the mortgage-backed securities. If the bonds are repaid early, investors face the risk of reinvesting at lower rates.

Purchasing Power Risk

Fixed income investors often focus on the real rate of return, or the actual return minus the rate of inflation. Rising inflation has a negative impact on real rates of return because inflation reduces the purchasing power of the investment income and principal.

GENERAL OBLIGATION BONDS: https://medicalexecutivepost.com/2022/03/24/general-obligation-and-revenue-bonds/

COMMENTS APPRECIATED

EDUCATION: Books

Like and Subscribe

***

***

Filed under: "Ask-an-Advisor", Experts Invited, finance, Financial Planning, Investing, Marcinko Associates, Portfolio Management | Tagged: bond risks, bonds, finance, fixed income risks, interest rate risks, Investing, liquidity risk, Marcinko, personal-finance, prepayment risks, price risks, purchasing power risk, reinvetment risks, stocks |