Bonds II: Default risk and market risk
It may come as a surprise to some people but, yes, bonds are risky; and, yes, money can be lost by investing in bonds, even in those of the safest kind. The sources of risk are many and varied but we’ll focus on the main two, default risk and market risk. (Before you start reading this chapter, make sure you’re clear about all the concepts discussed in the previous chapter.)
Sources of risk
Suppose we buy a corporate bond that matures in five years and we intend to hold it for only one year. What can go wrong? What are the sources of risk we face? Can we actually lose money? In a nutshell, many things can ...