What Every Investor Should Know
When you own a bond you have loaned money to a company or a governmental body that issues the bond to raise capital. In return, the issuer promises to repay the amount borrowed (face amount) plus interest. Bonds may be sold at prices higher or lower than
their face ("par") value. Generally, the higher the yield on a bond, the higher the risk of financial loss. More specifically, investing in bonds may involve:
Call risk — the potential for the issuer to repay the bond before its maturity date, which may happen if interest rates decline. Many municipal bonds (those issued by state or city governments) are "callable." Thus, investors should
learn more about the call provisions of the bond before buying it.
Credit risk — the possibility that the bond issuer may default, meaning it cannot repay principal and interest to the investor. Investors should research the credit rating of the bond issuer, but there is no assurance that an "AAA"
rating guarantees a certain investment return.
Interest rate risk — the potential for the market value of the bond to decline, if interest rates rise. Given that investors are attracted by higher rates, when the bond being sold offers a lower interest rate than the market, the
bond is less desirable and therefore, less valuable.
Inflation risk — the potential for the market value of the bond to decline, if consumer prices increase. Inflation reduces the purchasing power of the dollar, which means investors who receives a fixed rate of return can buy less
goods and services for their money.
Liquidity risk — the risk that there may not be an active market in which to sell the bond to another investor. Because the market for a particular bond may not be "liquid," prices quotes for the same bond may be different.
Read more about the various types of bonds and the risks associated with them before you invest.