VALUATION OF BONDS AND SUKUK - BOND RISKS (PT2)
The common misconception is that Bonds and Sukuk have little risk. THIS IS NOT TRUE.
Just like any other financial instruments, they have certain inherent risks but these can be reduced by diversification across other asset classes.
Credit Risk
Also known as ‘issuer risk’ or ‘default risk’. This is a risk that the issuer may not be able to meet its obligations in terms of coupon payments or may not be able to pay the principal amount back to the bondholders at maturity. Government bonds are generally considered risk-free, while corporate bond risks are measured by Rating Agencies.
Also known as ‘issuer risk’ or ‘default risk’. This is a risk that the issuer may not be able to meet its obligations in terms of coupon payments or may not be able to pay the principal amount back to the bondholders at maturity. Government bonds are generally considered risk-free, while corporate bond risks are measured by Rating Agencies.
Interest Rate Risk
Risk that the value of the bond may be adversely affected by the prevailing direction of interest rates. The single most important factor influencing the price of bonds is the prevailing market interest rate (e.g. if Bank Negara reduces interest rates, bonds become more attractive and its prices will rise) Therefore, the study of interest rate movements is important for bond trading.
Risk that the value of the bond may be adversely affected by the prevailing direction of interest rates. The single most important factor influencing the price of bonds is the prevailing market interest rate (e.g. if Bank Negara reduces interest rates, bonds become more attractive and its prices will rise) Therefore, the study of interest rate movements is important for bond trading.
Liquidity Risk
Risk that a bondholder may be unable to sell a bond due to thin trading conditions.
Risk that a bondholder may be unable to sell a bond due to thin trading conditions.
Inflation Risk
Risk that the value of a bondholder’s investment will be eroded by the effects of inflation. Fixed rate coupons and principal amounts will end up being less worthy in real terms if inflation is high during the bond’s lifetime.
Risk that the value of a bondholder’s investment will be eroded by the effects of inflation. Fixed rate coupons and principal amounts will end up being less worthy in real terms if inflation is high during the bond’s lifetime.
As a result of these risks, the price of the bond may fluctuate, thus resulting in capital gain or loss if the investor liquidates his holding.
In the case of a default, the investor may not receive payments of their interest and principal owing.
In the case of a default, the investor may not receive payments of their interest and principal owing.
