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Finance: What are the Major Risks in Owning Bonds? 1 Views
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Description:
What are the Major Risks in Owning Bonds? As bonds are basically securitized forms of debt, the bondholder’s primary risks are if the issuer defaults on return of principal at maturity and on interest payments. Other risks during interim ownership can include ratings downgrades, interest rate hikes by the Fed, market illiquidity, and forex risk if bonds are international or from an issuer with significant income from foreign nations.
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- Life Skills / Personal Finance
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- Life Skills / Finance Definitions
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- Subjects / Finance and Economics
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Transcript
- 00:00
Finance allah shmoop What are the major risks in owning
- 00:05
bonds Okay so first thing about risk Like if you're
- 00:11
one of those people who worries about asteroids dinosaur inhumanity
- 00:15
Well then really the best place for your savings is
- 00:17
probably in a certain aura casper Or you know whatever
Full Transcript
- 00:20
mattress brand you like Yeah go stuff those twenties into
- 00:24
their sleep on them And well we guess you pray
- 00:27
a lot Well if you have a bit more tolerance
- 00:29
for risk than buns air calling for you Historically most
- 00:32
funds are safe They boringly go along and pay their
- 00:36
interest and principal and investors get their five point two
- 00:39
eight nine seven percent returns or whatever the number is
- 00:42
And that's it No heroes no goats just interest payments
- 00:46
and peace So the bottom quartile of bonds i e
- 00:48
V e riskiest quarter of them is still way safer
- 00:52
than almost any equity or stock So the risks in
- 00:55
bond ownership kind of come from a different place not
- 00:59
necessarily from bankruptcy and the bonds not paying And yes
- 01:03
there exists a risk numeral you know in the company
- 01:06
or municipality or state going bankrupt Hello illinois California We're
- 01:10
looking at you and not paying the interest they oh
- 01:13
but that's an obvious risk and really rare in the
- 01:15
scheme of things Like in all the bonds issued its
- 01:18
some number in the very low zero point something percentages
- 01:22
of bonds that actually don't finally pay And this number
- 01:25
varies highly by era that is in the mortgage crisis
- 01:28
of a wave no Nine while there was a huge
- 01:30
spike in the number of bond delinquencies But in normal
- 01:32
eras where the world isn't in fact teetering on the
- 01:35
edge of bankruptcy a bond default is really rare So
- 01:39
the risk in bond ownerships more about the opportunity cost
- 01:42
of not owning stocks huh How's that go Well historically
- 01:45
the stock market is compounded it seven eight nine ten
- 01:48
percent a year and it doubles in value every seven
- 01:51
eight nine ten years Something like that Bonds with consummately
- 01:55
way less risk not surprisingly offer away less reward and
- 01:59
frankly poor tax structure because bond interest is tax at
- 02:03
ordinary income and stock appreciation is intact until you sell
- 02:06
it And even then it's tax at long term gain
- 02:09
rates usually so bonds compounded about half the rate of
- 02:12
the stock market or stocks or less obviously depending on
- 02:15
how much risk those bonds carrie right relative to where
- 02:18
we are in the market cycle and so on But
- 02:20
if you're feeling frisky and you buy junk bonds or
- 02:22
high risk or high yield bonds well there are other
- 02:25
risks beyond bankruptcy or looking over your shoulder and watching
- 02:28
the stock market boom While you're getting only eight percent
- 02:32
in year interest pre tax on your bonds right That
- 02:35
risk calls that is bond's yielding a whopping eight percent
- 02:39
have the risk that they get called early and refinanced
- 02:43
for only five percent The transaction makes a ton of
- 02:46
sense for the company who issued those high priced bonds
- 02:48
It stays a mil three percent a year on big
- 02:51
dollar amounts and that could be huge like taking a
- 02:54
four hundred million dollars of debt And instead of paying
- 02:56
eight percent on that well you're only paying five percent
- 02:59
or something like that right But the risk then extends
- 03:01
to the investor who thought they were buying a nice
- 03:05
set of cash flows at eight percent on i'll say
- 03:07
the hundred grand they invested or they'd get eight grand
- 03:10
a year in interest on that investment bonds only to
- 03:13
wake up one day with their hundred grand re funded
- 03:16
maybe with a grand or two in premium or tip
- 03:18
to say thank you for the short ride pal with
- 03:20
the company then offering the same risk bonds for just
- 03:23
five grand a year in bond rent money instead of 00:03:26.21 --> [endTime] eight So yeah
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