Fixed Income Risks

Despite an investment being “fixed” income, it can carry multiple risks. These risks exist due to the features of a bond, such as the creditworthiness of its issuer or the maturity a certain bond has.

Interest rate risk

Fixed-income securities are sensitive to changes in interest rates. When interest rates rise, the value of existing fixed-income securities falls, and vice versa. This can result in capital losses for investors.

Credit risk

Fixed-income securities are also subject to credit risk, the risk that the security issuer will default on its payments. This risk is higher for lower-quality securities, such as high-yield or junk bonds.

Inflation risk

Fixed-income securities are also subject to inflation risk, which is the risk that inflation will erode the purchasing power of fixed-income payments over time. This risk is particularly relevant for long-term fixed-income investments.

Liquidity risk

Some fixed-income securities may be less liquid than others, making it difficult for investors to sell their holdings at a fair price.

Call risk

Some fixed-income securities, such as callable bonds, give the issuer the right to call the security back before maturity. This can result in lower returns for investors if the security is called back when interest rates are low.

Prepayment risk

For mortgage-backed securities, there is the risk that borrowers will prepay their mortgages, resulting in lower returns for investors if interest rates have fallen since the security was issued.