Bond Holder Risks

Question 1

DEFAULT RISK (CREDIT RISK)

Answer 1

RISK THAT THE ISSUER MAY DEFAULT ON THE LOAN

• THE CREDIT RISK OF TREASURY BONDS IS 0
• MOODYS, S&P, AND FITCH ALL RATE CORPORATE BONDS FOR THEIR RISK ON DEFAULT
• HIGH YIELD IS GENERALLY ASSOCIATED WITH LOW QUALITY/HIGH RISK
• LOW YIELD IS ASSOCIATED WITH HIGH QUALITY/LOW RISK

Question 2

INTEREST RATE RISK

Answer 2

RISK THAT INTEREST RATES WILL GO UP LEAVING YOUR BOND LESS DESIRABLE
*LONG TERM BONDS ARE MOST SUSCEPTIBLE

Question 3

PURCHASING POWER RISK

Answer 3

RISK THAT INFLATION WILL DEVALUE A BOND BECAUSE MONEY WONT BE WORTH WHAT IT WAS WHEN THE BOND WAS PURCHASED

• FIXED INCOME INVESTMENTS ARE MOST SUSCEPTIBLE DUE TO INFLATION
• INFLATION OCCURS IN TIMES OF EXPANSION, BEST CHOICE = STOCKS
• DEFLATION OCCURS IN TIMES OF CONTRACTION, BEST CHOICE= BONDS

Question 4

During times of EXPANSION what happens and what should you be in?

Answer 4

INFLATION

STOCKS

Question 5

During times of CONTRACTION what happens and what should you be in?

Answer 5

DEFLATION

BONDS

Question 6

CALL RISK

Answer 6

THE RISK THAT INTEREST RATES WILL DROP AND INVESTORS WILL HAVE THEIR BONDS CALLED

*IF THIS HAPPENS, A BOND INVESTOR MUST REINVEST HIS MONEY, PROBABLY AT A LOWER RATE

Question 7

REINVESTMENT RISK

Answer 7

*FUTURE INTEREST PAYMENTS WILL HAVE TO BE REINVESTED AND FUTURE INTEREST RATES ARE UNKNOWN AND HENCE A RISK

*ZERO COUPON BONDS, SUCH AS TREASURY STRIPS, HAVE NOOOOO REINVESTMENT RISK BECAUSE THEY HAVE NOT INTEREST PAYMENTS.
ALL GAINS ARE RECEIVED AT MATURITY.