Bond-Risks associated with it.

BasuNivesh now available in it’s own domain www.basunivesh.com from 22nd June 2012.

Want to start this post with one happy note. Financial Planning Standards Board India (FPSB India) which is a lone board to  certify  Financial Planners in India, accepted my experience credentials which is mandatory after clearing my exams and  education, permitted me to use the certification mark as CERTIFIED FINANCIAL PLANNER^CM  or  with my name. So, now I am Certified Financial Planner!!!!

It is common perception to judge Bond as safe investment like Bank Fixed Deposits in terms of returns and risk. But their are so many risks associated with it. Hence I thought to share those with you all. First I will make you familiar with Bonds and it’s terminologies.

Bonds in simple language is, loan you are giving to the government or to company which in return will give you specified Coupon amount (return on your investment). Coupon is either on specific intervals or you can get it on maturity. Bonds which not pay any coupons during it’s tenure is usually  called Zero Coupon Bond. You will get the discounted rate to Face Value (Maturity Value) while purchasing for Zero Coupon Bonds. Difference between Issue Price (Purchasing Price) and Face Value is your return.

Now I will show you the risks associated with it.

1) Interest Rate Risk- When interest rate falls, Bonds Prices rises, conversely, when interest rate increase, Bond Prices decrease. Longer the maturity period of Bond higher the interest rate risk. So, wise thing now as RBI is steadily decreasing Interest Rate means start to invest in Bonds.

2) Reinvestment Risk-When the trend is declining interest rate then investor has no choice but to invest in prevailing interest rate which may cause him receiving less return for his future goals.

3) Inflation Risk-Higher Inflation means higher Interest Rates. Higher Interest Rates means lower Bond Price. Hence Bond prices are also associated with Inflation risk.

4) Call Risk-Some companies have attached “Call Option” with bonds. Which means, after certain period they may call back bonds by paying you the returns. Hence when interest rate in market down compare to what you are getting in Bonds then their is certainty that the issuing company may exercise this option. By this you may loose good return at that time.

5) Liquidity Risk-When investor intends to sell bonds in secondary market, he may not get the buyers. This is specifically with low rated bonds.

6) Default Risk-The issuing company may default you in paying coupon amount or maturity amount due to it’s financial crunch. Hence choose the Bond which have good rating.

These are the few risks which you need to look for before investing in Bonds. So, choose the Bonds which have good rating by rating agencies and this is the best time to purchase as everyone is predicting interest rate decline in future. Hope these points made you clear about the risks associated with Bond.