Scribd
Upload
105 views15 pages

Risks in Fixed Income Investments

This document outlines the various risks associated with investing in fixed-income securities. It discusses two components of return - change in market value and cash flows received. It then describes several types of risks in detail, including interest rate risk, reinvestment risk, timing/call risk, credit risk, yield curve/maturity risk, inflation risk, liquidity risk, exchange rate risk, volatility risk, and political/legal risk. These risks can impact the value and returns of fixed-income investments.

Uploaded by

osiccor
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
105 views15 pages

Risks in Fixed Income Investments

This document outlines the various risks associated with investing in fixed-income securities. It discusses two components of return - change in market value and cash flows received. It then describes several types of risks in detail, including interest rate risk, reinvestment risk, timing/call risk, credit risk, yield curve/maturity risk, inflation risk, liquidity risk, exchange rate risk, volatility risk, and political/legal risk. These risks can impact the value and returns of fixed-income investments.

Uploaded by

osiccor
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

RisksAssociatedwithFixed IncomeSecuri8es

ReturnComponents
Returnobtainedfrominves8nginaxed incomesecurityfromthedayitispurchased tothedayitissoldhastwocomponents:
Changeinmarketvalue Cashowsreceivedfromthesecurityduringthe 8meitisheld,plusaddi8onalincomefrom reinvestmentofthesecashows

RisksAssociatedwithFixedIncome Investments
Market,orinterestraterisk Reinvestmentrisk Timing,orcall,risk Credit,ordefault,risk Yieldcurve,ormaturity,risk Ina8on,orpurchasingpower,risk Liquidityrisk Exchangerate,orcurrency,risk Vola8lityrisk Poli8calorlegalrisk

InterestRateRisk
Mostimportantriskformostxedincome investors. Usually,thevalueofaxedincomesecurity decreasesasinterestratesrise. Sellingwhenrateshaverisenwillresultinaloss. Thereareexcep8ons(e.g.putop8ons). Domes8ctreasuryyieldcurveismostcommon benchmarkformeasuringratechanges.

ReinvestmentRisk
Returnearnedwhenreinves8ngthecash owsofaxedincomesecuritydependson theprevailingmarketrateswhenthosecash owsarereceived. Theriskisthatrateswillbelowwhencash owsbecomeavailableforreinvestment.

Timing/CallRisk
Ifthexedincomesecurityhasacall provision,thecashowsreceivedare uncertain. Callfeaturesexacerbaterevinvestmentrisk:
Bondswilltendtobecalledwheninterestrates arelow(issuercangetcheaperfundingby renancing).

Aversionofthisriskistheprepaymentriskof mortgagebackedsecuri8es.

CreditRisk
Riskduetoachangeinthecreditworthiness oftheissuer. Defaultrisk
Recoveryrisk

Migra8onrisk Spreadrisk(oTenconsideredapartofmarket risk).

TreasuryEurodollarSpread(TEDSpread)

Source:Wikipedia

YieldCurve/MaturityRisk
Theyieldcurvereferstothecurrentmarket informa8ongivingtheyieldtomaturityforbonds ofdierentdura8ons. Itcanbeusedtomakeassump8onsaboutthe futurebehaviourofinterestrates. Investmentdecisionsmaybemadebasedona par8cularassump8ononthebehaviourofthe yieldcurve.
Theobtainedreturnwillbeaectedbydevia8onsof actualinterestratesthatprevailinthefuturefrom thoseinferredfromthecurrentyieldcurve.

Ina8onRisk
Ina8onaectsthevalueoffuturecashows, whenmeasuredintermsofpurchasingpower. Unlessthebondisina8onlinked,theholder hasanexposuretothisrisk.

LiquidityRisk
Flighttoqualityscenarios
Investorsrushtothesafestpossiblesecuri8es ([Link]) Pricesofallothersecuri8esdropdrama8cally E.g.AugustSeptember1998,September2008

Wideningbidaskspreads(highertransac8ons costsduetolowerliquidity). Fundingliquidityrisk([Link]).

ExchangeRateRisk
Receivingcashows([Link] bond)inacurrencyotherthanthedomes8c currencyexposesaninvestortoexchangerate risk. Holdingbondsissuedinanothercountryalso exposesaninvestortotheinterestraterisk fromthatcountry.

Vola8lityRisk
Interestratevola8lityaectsthevalueof op8onsembeddedinbonds([Link], putablebonds,prepaymentop8ons embeddedinmortgagebackedsecuri8es). Thevalueoftheseop8onsincreaseswith increasingratevola8lity. Iftheseop8onsaregrantedtotheissuer(asin callablebonds,MBS)thepriceofthesecurity willdecreasewhenvola8lityincreases.

Poli8cal/LegalRisk
Taxpolicy Abilitytoenforcebondcovenants Legalstatusofthedebt([Link] bankruptcy,restructuring)

EventandSectorRisk
EventRisk:Theabilityofanissuertomeetits obliga8onsmightbeaectedbyaseriousand unexpectedchangeduetoasuddenevent.
Naturalorindustrialaccident Takeoverorcorporaterestructuring

SectorRisk:Riskduetothepossibilityof adversedieren8almovementsofspecic sectorsofthemarket.

You might also like