Bond mutual fund investors should consider these forms of risk because fund managers are capable of buying and selling bonds as often as they find it appropriate to meet the fund's objective. Fund investors hence risk loss because of variations in the value of the fund. Following are the risks associated with investment in bonds:
Interest Rate Risk Diversification
Since the price of a bond changes as with the changes in the market interest rates, the risks that an investor gets to face is that the price of a bond will drop in case the market interest rates rise. This risk is known as interest rate risk and is the most common risk faced by investors in the bond market.
Failure in timely payment of interest by principal issuer will let the investor face credit risk. Credit risk is less of a factor for bond funds that invest in insured bonds or Treasury bonds. In comparison, people who invest in the bonds of companies with poor credit ratings are generally subjected to higher risk.
The company facing difficulty in selling an asset is termed as Liquidity Risk. To summarize, an investment that needs to be sold early because there is not enough cash equivalents or because there is lack of inefficient market to meet the financial needs is called as Liquidity Risk. In the case of bonds too selling a bond below its indicated value may expose the investor to liquidity risk. When an investor wants to sell a bond prior to the maturity date, he is concerned with whether or not the bid price from broker or dealers is near enough to the indicated value of the issue.
This risk rises from the decline in the value of a security’s cash flows due to inflation may result in Inflation risk.