Risks Associated With Investing In Bonds Flashcards
Interest rate risk
When the price of a bond held in a portfolio declines because of the rise in market interest rates
Reason for an inverse relationship between changes in interest rates and bond prices
If interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price
Corporate rate less than yield required by market
price less than par value
Par value
Corporate rate greater than yield required by market
Price is greater than par value
premium
Impact of maturity
The longer the bonds maturity, the greater the bond’s price sensitivity to changes in interest rates
Impact of coupon rate
The lower the coupon rate, the greater the bond’s price sensitivity to changes in interest rates
Impact of embedded options
Change depending on how the value of the embedded options changes when interest rate changes
Embedded call option
A benefit to the issuer and a disadvantage to the bondholder
subtracted from the option free Bond
Option free Bond
Once the embedded call option is deducted, it increases when interest rates decline
Duration
A measure of the price sensitivity of a bond to a change in yield
Yield Curve risk
Affect the price sensitivity of a portfolio of bonds
an adverse shift in market interest rates
Impact of yield level
The higher the bond yield, the lower the price sensitivity
Measuring interest rate risk
Percentage price change from initial price
dollar price change from initial price change
Rate shock
Change in yield basis points
Call risk
The risk for a bond buyer that exists in purchasing a callable bond