The main risks arising from investing in secondary market debt instruments include:
- Credit/Default Risk
The issuer of the debt instrument may not be able to pay interest or repay the principal amount. This may lead to financial loss, or investors may not receive the full repayment of the investment.
- Liquidity Risk
This occurs when investors are unable to sell their debt instrument before maturity at a desired time or price due to unfavorable liquidity conditions in the market.
- Interest Rate Risk
The price of debt instruments will decline due to changes in interest rates. Rising interest rates generally lead to a decrease in the value of debt instruments.
- Reinvestment Risk
This arises when investors receive cash flows, such as principal or interest payments, and are unable to reinvest at the same rate of return as the initial investment.
- Event Risk
Unforeseen events can affect the issuer or the market such as company mergers whereby legal changes impact operations, etc. These risks are rare but can have a significant impact on the company. Investors may reduce this risk by diversifying their investments to reduce the impact of unexpected events.