CHAPTER 5
Bond Risk
Introduction
Investment risk is the possibility that the actual rate of return realized from an investment will differ from the expected rate. For bond investors, there are three types of risk: (1) default risk: the possibility that the issuer/borrower will fail to meet the contractual obligations specified in the indenture; (2) call risk: the possibility that the issuer/borrower will buy back the bond, forcing the investor to reinvest in a market with lower interest rates; and (3) interest rate risk or bond market risk: the possibility that interest rates will change, changing the price of the bond and the return earned from reinvesting coupons. In this chapter, we examine these three types of risks and introduce two measures ...
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