5

Bond risks

Risks

Duration

Convexity

Comparison

Exercise

Summary

 

File: MFMaths3e_05.xls

RISKS

Bonds can be analysed as a trade-off between risk and return. Since the value of investments can vary due to a number of factors and the values of the coupon payments are normally fixed, investors need to understand the potential risks before investment. Risk factors can also change during the investment period, so investors need to make decisions on whether to hold, reduce or increase the investment. There are several classes of risk, which include:

  • changes in interest rates;
  • reinvestment risk on the coupons and principal;
  • yield curve risk;
  • prepayment and call risk;
  • credit risk defined as default and downgrading;
  • liquidity;
  • exchange rates;
  • inflation; ...

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