Tuesday, May 4, 2010

Bonds are not totally risk free investment

Bonds are less risky than the equity but it doesn’t meant its risk averse bonds investment are default risk as well as the interest rate risk.

If the market down and recession than there is no option to save the investment by any means .

1.Default Risk:

Suppose any company become bankrupt than the investor lost there whole investment.is the some part paid in the future than also the investor loss the current market value of the rupee.

2.Interest rate risk:

Interest rate risk will arise with changing in the interest rate in the market.Bonds are not held till maturity ,in that case the investor get the low amount of there investment that means price loss.If the hold the bonds till maturity than the suffer from the capital loss if the market price of the bonds reduce.

Change in the price fluctuation caused by the interest rate elasticity of bonds .Increase in the interest rate has increase the interest income as well as the reinvestment of that income gives the higher income .Increase in the interest rate reduce the market value of the bonds menace the investor get lower return by resumption of the bonds .It menace that increase in the interest rate has positive reinvestment effect but negative price effect.On the other hand reduce in the interest rate ,reduce the reinvestment income but the resumption value of the bonds increase due to reduce in market interest rate,that means the reduce in the interest rate has negative effect on the reinvestment but positive price effect.

To protect the investment from the elasticity of interest rate change ,Bond immunization is the right way.

Bonds immunization not depend on redemption value(yield to maturity) of the bonds ,it depends on the duration of the bonds.

If a liability needs to be paid after a particular time period then the investor needs to go for the Bond immunization which is exactly of the same duration as liability period and here the interest rates are on compound basis.

Bonds immunization helps to protect from the fluctuating interest rate market.

1 comment:

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