Bonds reduce the overall risk of a portfolio by increasing its diversity.
Bonds are susceptible to the following seven risks: (1) interest-rate risk, (2) inflation risk, (3) company risk, (4) financial risk, (5) liquidity risk, (6) political or regulatory risk, and (7) exchange-rate risk.
A bond’s rating is a measure of the default risk associated with a company’s bonds. A high rating means that the bond has less risk than a similar bond with a lower rating. Standard & Poor’s highest bond rating is AAA. Its lowest bond rating is D.
The six major categories of bonds are (1) corporate bonds, (2) U.S. Treasury Debt Securities, (3) municipal bonds, (4) agency bonds, (5) international bonds, and (6) U.S. Treasury Savings Securities.
The value of a bond is determined by the price an investor is willing to pay for the bond. The three things that affect bond prices are (1) the par value, (2) the market interest rate and length of maturity, and (3) the discount rate.
