Purchasing power risk
Refers to the risk that the purchasing power of money will decrease due to inflation. During the period of inflation, the investor's real interest rate should be coupon rate minus the inflation rate. If the bond interest rate is 10%, the inflation rate is 8%, and the real rate of return is only 2%, the purchasing power risk is the most common risk in bond investment. In fact, from the late 1980s to the early 1990s, due to the high inflation of the national economy, the national debt issued by China did not sell well.
Avoidance method: For purchasing power risk, the best way to avoid it is to diversify investment, so that the risk brought by the decline of purchasing power can be compensated by some investment income with higher income. The usual practice is to invest some funds in higher-yielding investment methods, such as stocks and futures, but the risks brought about by it also increase.
(2) Default risk
Refers to the risk that the borrower who issues bonds cannot pay interest or repay the principal on time, which brings losses to bond investors. Among all bonds, the government bonds issued by the Ministry of Finance are often considered as gilt-edged bonds by the market because of government guarantees, so there is no risk of default. However, bonds issued by companies other than local governments and central governments are more or less at risk of default. Therefore, credit rating agencies should evaluate bonds to reflect their default risk (bond rating will be further discussed later in this section). Generally speaking, if the market thinks that the default risk of a bond is relatively high, then it will require the bond to have a higher yield to make up for the possible losses.
Avoidance method: Default risk is generally the risk brought by the poor operating condition or bad reputation of the company or entity that issues bonds, so the most direct way to avoid default risk is not to buy bonds with poor quality. When choosing bonds, we must carefully understand the company's situation, including the company's operating conditions and the company's past bond redemption, and try to avoid investing in corporate bonds with poor operating conditions or bad reputation. During the period of holding bonds, we should try our best to understand the company's operating conditions so as to make a decision to sell bonds in time. At the same time, due to the low investment risk of national debt, conservative investors should try to choose national debt with low investment risk.
(3) Interest rate risk of bonds
Refers to the risk of investors suffering losses due to changes in interest rates. Undoubtedly, interest rate is one of the important factors affecting bond prices: when interest rate rises, bond prices fall; When interest rates fall, the price of bonds will rise. Because the bond price will change with interest rate, even the national debt without default risk will have interest rate risk.
Evasion method: the preventive measures should be diversification of bond maturity and long-term and short-term cooperation If interest rates rise, short-term investments can quickly find high-yield investment opportunities, while long-term bonds can maintain high returns if interest rates fall. In short, there is an old saying: Don't put all your eggs in one basket.
liquidity risk
Refers to the risk that investors cannot sell bonds at a reasonable price in the short term. If an investor meets a better investment opportunity and wants to sell the existing bonds, but he can't find a buyer who is willing to pay a reasonable price in the short term, and it takes a long time to find a buyer when the price drops to a very low level, then he will either suffer reduced losses or lose new investment opportunities.
Avoidance method: In view of the liquidity risk, investors should try to choose bonds with active trading, such as national debt, so as to be recognized by others, and it is best not to buy unpopular bonds. Before investing in bonds, you should also think carefully and prepare a certain amount of cash for emergencies. After all, transferring bonds halfway will not bring good returns to bondholders.
Avoidance method: For the reinvestment risk, the preventive measures should be to diversify the bond term and cooperate in the long and short term. If interest rates rise, short-term investments can quickly find high-yield investment opportunities, while long-term bonds can maintain high returns if interest rates fall. In other words, it is necessary to diversify investment to spread risks and let some risks offset each other.
(v) Operational risks
Refers to the mistakes made by the management and decision-makers of bond issuers in the process of operation and management, which leads to the decrease of assets and the loss of bond investors.
Avoidance method: In order to prevent business risks, we must investigate the company when choosing bonds, and understand its profitability, solvency and reputation by analyzing its statements. Because the investment risk of national debt is very small, while the interest rate of corporate bonds is high but the investment risk is high, it is necessary to balance the income and risk.
(vi) Reinvestment risk
Investors can get the following three benefits by investing in bonds:
1. Bond interest;
2. Bond trading income;
3. Interest earned by reinvesting in temporary cash flows (such as interest received regularly and principal repaid when due).
In fact, the reinvestment risk is aimed at the third kind of income. In the next chapter, we will see that in order to achieve a return equal to that determined when buying bonds, investors must reinvest these temporary cash flows with a return equal to that determined when buying bonds.