Bonus: The risks that are involved
Interest Rate Risk
Rising interest rates pose a risk to all types of bonds. When interest rates go up, the value of bonds go down. That’s because investors prefer to buy new bonds with higher yields, rather than older bonds with lower rates.
Detractors say interest rate risk is a major risk. If rates rise and you sell a bond, you will lose money. But remember if you keep the bond until its maturity, you continue getting interest payments and then get your principal back as expected as long as the issuer doesn’t default.
Default or Credit Risk
Default or credit risk is the risk that the company or city (remember Detroit?) could go bankrupt and not make payments. Naturally, companies regarded as riskier pay higher rates, while those seen as safer, like the U.S. government, pay lower rates. Investors can gauge default risk by examining ratings from credit rating agencies like Standard & Poor’s and Moody’s and mitigate risk by creating a diversified portfolio.
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