Six biggest bond risks

• Interest Rate Risk and Bond Prices.
• Reinvestment Risk and Callable Bonds.
• Inflation Risk and Bond Duration.
• Credit/Default Risk of Bonds.
• Rating Downgrades of Bonds.
• Liquidity Risk of Bonds.

  How do you mitigate interest risk?

  Interest rate risk can be reduced by holding bonds of different durations, and investors may also allay interest rate risk by hedging fixed-income investments with interest rate swaps, options, or other interest rate derivatives.

  How are bond prices related to interest rate risk?

  Bond price risk is closely related to fluctuations in interest rates. Fixed-rate bonds are subject to interest rate risk, meaning that their market prices will decrease in value when the generally prevailing interest rates rise. Since the payments are fixed, a decrease in the market price of the bond means an increase in its yield.

  How is the duration of a bond related to its risk?

  The higher the duration number, the more sensitive your bond investment will be to changes in interest rates. Duration risk is the name economists give to the risk associated with the sensitivity of a bond’s price to a one percent change in interest rates.

  How does an investor manage interest rate risk?

  Interest rate risk can be managed through hedging or diversification strategies that reduce a portfolio’s effective duration or negate the effect of rate changes. For more on this, see: Managing interest rate risk. For example, say an investor buys a five-year, $500 bond with a 3% coupon. Then, interest rates rise to 4%.

  What are the dangers of investing in bonds?

  2. Reinvestment Risk and Callable Bonds Another danger that bond investors face is reinvestment risk, which is the risk of having to reinvest proceeds at a lower rate than the funds were previously earning. One of the main ways this risk presents itself is when interest rates fall over time and callable bonds are exercised by the issuers.