Bonds are debt instruments issued by a government, corporation, or governmental agency which covers money the bondholder has lent. A person who owns a bond of a company is actually a creditor of that company. Bonds can be taxable or non taxable. If a person buys a taxable bond he takes some risks.
The risks involved in buying taxable bonds are mainly of three types — liquidity risks, credit risks and prepayment risks. A detailed overview of these three risks will help us to understand whether to buy taxable bonds or not.
Liquidity Risks:
When a bond has little or no active trading in the market, it becomes quite difficult to buy or sell the security at or near its fair value which may lead to a dramatic decline in the bond funds share price.
Credit Risks:
The company’s ability to make interest and principal payments in a timely manner depends upon its credit quality. There are agencies which have their own independent rating systems, but generally the issuer may fail to meet the obligations if a higher rating is assigned to it. Bonds which have lower investment grades (BB or lower) have to pay a yield much higher in order to compensate investors for the increased credit risks.
Prepayment Risks:
Many asset-backed bonds and mortgage-backed bonds may generally be applicable to a prepayment risk. Due to decline in interest rates many kinds of mortgage securities may be paid early when homeowners decide to refinance their mortgages. The bond funds are reinvested at lower prevailing rates which reduces performance.
About Author: Pauline Go is an online leading expert in finance industry. She also offers top quality finance tips like :
Bond Broker Phone Number And Address Directory,
What is Bond Convexity,
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