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Finance: What are the Major Risks in Owning Bonds? 1 Views


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What are the Major Risks in Owning Bonds? As bonds are basically securitized forms of debt, the bondholder’s primary risks are if the issuer defaults on return of principal at maturity and on interest payments. Other risks during interim ownership can include ratings downgrades, interest rate hikes by the Fed, market illiquidity, and forex risk if bonds are international or from an issuer with significant income from foreign nations.

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Transcript

00:00

Finance allah shmoop What are the major risks in owning

00:05

bonds Okay so first thing about risk Like if you're

00:11

one of those people who worries about asteroids dinosaur inhumanity

00:15

Well then really the best place for your savings is

00:17

probably in a certain aura casper Or you know whatever

00:20

mattress brand you like Yeah go stuff those twenties into

00:24

their sleep on them And well we guess you pray

00:27

a lot Well if you have a bit more tolerance

00:29

for risk than buns air calling for you Historically most

00:32

funds are safe They boringly go along and pay their

00:36

interest and principal and investors get their five point two

00:39

eight nine seven percent returns or whatever the number is

00:42

And that's it No heroes no goats just interest payments

00:46

and peace So the bottom quartile of bonds i e

00:48

V e riskiest quarter of them is still way safer

00:52

than almost any equity or stock So the risks in

00:55

bond ownership kind of come from a different place not

00:59

necessarily from bankruptcy and the bonds not paying And yes

01:03

there exists a risk numeral you know in the company

01:06

or municipality or state going bankrupt Hello illinois California We're

01:10

looking at you and not paying the interest they oh

01:13

but that's an obvious risk and really rare in the

01:15

scheme of things Like in all the bonds issued its

01:18

some number in the very low zero point something percentages

01:22

of bonds that actually don't finally pay And this number

01:25

varies highly by era that is in the mortgage crisis

01:28

of a wave no Nine while there was a huge

01:30

spike in the number of bond delinquencies But in normal

01:32

eras where the world isn't in fact teetering on the

01:35

edge of bankruptcy a bond default is really rare So

01:39

the risk in bond ownerships more about the opportunity cost

01:42

of not owning stocks huh How's that go Well historically

01:45

the stock market is compounded it seven eight nine ten

01:48

percent a year and it doubles in value every seven

01:51

eight nine ten years Something like that Bonds with consummately

01:55

way less risk not surprisingly offer away less reward and

01:59

frankly poor tax structure because bond interest is tax at

02:03

ordinary income and stock appreciation is intact until you sell

02:06

it And even then it's tax at long term gain

02:09

rates usually so bonds compounded about half the rate of

02:12

the stock market or stocks or less obviously depending on

02:15

how much risk those bonds carrie right relative to where

02:18

we are in the market cycle and so on But

02:20

if you're feeling frisky and you buy junk bonds or

02:22

high risk or high yield bonds well there are other

02:25

risks beyond bankruptcy or looking over your shoulder and watching

02:28

the stock market boom While you're getting only eight percent

02:32

in year interest pre tax on your bonds right That

02:35

risk calls that is bond's yielding a whopping eight percent

02:39

have the risk that they get called early and refinanced

02:43

for only five percent The transaction makes a ton of

02:46

sense for the company who issued those high priced bonds

02:48

It stays a mil three percent a year on big

02:51

dollar amounts and that could be huge like taking a

02:54

four hundred million dollars of debt And instead of paying

02:56

eight percent on that well you're only paying five percent

02:59

or something like that right But the risk then extends

03:01

to the investor who thought they were buying a nice

03:05

set of cash flows at eight percent on i'll say

03:07

the hundred grand they invested or they'd get eight grand

03:10

a year in interest on that investment bonds only to

03:13

wake up one day with their hundred grand re funded

03:16

maybe with a grand or two in premium or tip

03:18

to say thank you for the short ride pal with

03:20

the company then offering the same risk bonds for just

03:23

five grand a year in bond rent money instead of 00:03:26.21 --> [endTime] eight So yeah

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