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Risks in Bond Investment
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- Interest Rate Risk or Price Risk - This is the risk that market interest rates might change after the purchase of a bond. The price of a bond moves in the opposite direction to market interest rates. This means the price of a bond falls when the current market interest rate goes up, and rises when interest rates go down. If bondholders sell when the current market interest rate is lower than the interest rate when they purchased the bond, they will sell the bond at a profit and vice versa if interest rates rise.
- Default Risk - This is the risk that a bond issuer will be unable to pay the interest or the principal as stated in a bond. Credit ratings are a useful guide to the level of risk.
- Liquidity Risk - This is the risk that a bond will be difficult to be resold on the secondary market. This is more likely to be associated with corporate bonds or debentures than government bonds as debentures are less likely to be traded on the secondary market than government bonds.
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