Quite simple, isn’t it? Here we explain again in detail which two risks you should be aware of in relation to bonds:
- Credit risk (also known as issuer risk): credit risk is the danger of the debtor becoming insolvent. This can result in the partial or total loss of the capital invested. If a borrower has lower creditworthiness, there is a higher risk. The borrower’s creditworthiness can change during the term of the bond. However, as the coupon, or interest rate, is fixed and does not change over the term, the difference between the coupon and the actual risk can offset a price correction to the bond for new investors.
- Interest rate risk (also known as market risk): fluctuations in interest rates can have a negative or positive impact on the value of fixed-interest bonds. The longer the remaining maturity of the bond, the higher the price change. Bonds with a high interest rate in a low interest rate environment are more valuable than low interest-bearing bonds when market rates are high. These scenarios can occur as bonds bear interest at a fixed rate over several years, whereas market rates can change constantly.