A:

The main factors that impact the prices of fixed income securities include interest rate changes, default or credit risk, and secondary market liquidity risk. Fixed income securities are loans made by an investor to a government or corporate borrower. The issuer of the bond agrees to pay a fixed amount of interest on a regular schedule until the maturity date of the bond. At the maturity date, the borrower returns the principal amount to the investor. The fixed amount of interest is known as the coupon rate, whereas the principal amount of the bond is known as the par or face value. There are a number of different type of fixed income securities, including U.S. Treasurys, corporate bonds, high yield bonds and tax-free municipal bonds.

The main risk that can impact the price of bonds is a change in the prevailing interest rate. The price of a bond and interest rates are inversely related. As interest rates rise, the price of bonds falls, since investors can obtain bonds with a superior interest rate, which decreases the value of a bond that has already been issued. On the flip side, current bond holders are benefited by a drop in interest rates, which makes their bonds more valuable; other investors seek out higher yields of previously issued bonds. Bonds with longer maturities are subject to greater price movement upon interest rate changes, since an interest rate change has a larger impact on the future value of the coupon.

The second main factor is credit or default risk. There is a risk of default if the issuer will go out of business and be unable to pay its interest rate and principal obligations. Issuers of high-yield bonds have more credit risk, since there is likely a greater risk of default. To compensate investors for this higher risk, such bonds often pay higher interest rates. Credit rating agencies provide credit ratings for the issuers of bonds and can help investors gauge the risk associated with certain corporate bonds.

Except for government debt, most bonds are traded over the counter (OTC) and therefore carry a liquidity risk. Unlike the stock market, where investors can easily exit a position, bond investors rely on the secondary market to trade bonds. Investors who need to exit a bond position to access their invested principal may have a limited secondary market to sell the bond. Further, due to the thinner market for bonds, it can be difficult to get current pricing. Bonds vary so much in their maturities, yields and the credit rating of the issuer that centralized trading is difficult. However, FINRA introduced the Trade Reporting and Compliance Engine in 2002, which now reports a high percentage of OTC bond trades, thereby increasing transparency in the bond market.

RELATED FAQS
  1. What causes a bond's price to rise?

    Learn about factors that influence the price of a bond, such as interest rate changes, credit rating, yield and overall market ... Read Answer >>
  2. What are the risks of investing in a bond?

    The most well-known risk in the bond market is interest rate risk - the risk that bond prices will fall as interest rates ... Read Answer >>
Related Articles
  1. Investing

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  2. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
  3. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  4. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  5. Financial Advisor

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  6. Investing

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
RELATED TERMS
  1. Bond

    A bond is a fixed income investment in which an investor loans ...
  2. Fixed-Income Security

    A fixed income security is an investment that provides a return ...
  3. Discount Bond

    A discount bond is a bond that is issued for less than its par ...
  4. Bond Ladder

    A portfolio of fixed-income securities in which each security ...
  5. Corporate Bond

    A debt security issued by a corporation and sold to investors. ...
  6. Callable Bond

    A callable bond is a bond that can be redeemed by the issuer ...
Hot Definitions
  1. Liquid Asset

    An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally ...
  2. Nostro Account

    A bank account held in a foreign country by a domestic bank, denominated in the currency of that country. Nostro accounts ...
  3. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  4. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  5. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  6. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
Trading Center