Bond instruments or debt instruments are considered to be safe investment. However, there is always an element of risk in most investments. Investing is bonds is less risky as compared to equity investments. However, there is little amount of risk involved in bond as well. Take a look at the risks involved.
1) Interest Rate Risk
Interest rates and bond prices are inversely related, any changes in interest rates will impact bond prices. The rise in interest rates will take the bond price lower and vise-verse. Bond markets are bullish when interest rates are low or falling.
2) Call Risk
In certain type of Bonds there is an option of the issuer calling for bond before maturity. In case of declining interest rate regime, bond issuer may call for the bond to protect them from interest rate drop.
3) Reinvestment Risk
The bondholder is exposed to the risk of investing the proceeds of the bond (or coupon payments) at lower interest rates after the bond is called. This is known as reinvestment risk which is followed after bonds are called by issuer. The bondholder will be left with pile of money, at that point he may not fetch the required returns.
4) Inflation Risk
As bondholders receive fixed payment called as coupon for the duration of the bond held, inflation could eat into returns. For example, if interest rate or coupon rate is 7 per cent and inflation keeps rising and touches 9 per cent, your real rate of return becomes negative bond.
5) Credit or Default Risk
When a individual buys a bond, he is just receiving a certificate of debt from the issuer. Many investors don't understand that corporate bonds aren't guaranteed, they fall for high interest rate and invest. One should at least consider ratings on the bond, which will help them recognize the risk associated with bond. And there are always chances that company going bankrupt or may fail to pay coupon and principal.
6) Rating Downgrade Risk
Credit ratings services such as Moody's, Standard & Poor's and Fitch provide credit ratings to bond issues. Any downgrade by rating agencies can lead to low bond prices.