Types bonds- Financial Economics by ClassOf1

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									              Sub: Economics                                                             Topic: Financial Economics



              Question:

               Explain the two main risks bondholders face?

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              After doing some research on the Internet, Mark is considering investing his life savings in
              corporate bonds. He's not really sure what they are, however, and wants you to explain them
              to him
              a. What is a bond?
              b. Explain the two main risks bondholders face?


              Solution:
              a. Basically a bond is a debt security, issued to the public or to institutional investors in which
              the authorized issuer owes the holders a debt and is obliged to repay the principal and interest
              at a later date called maturity. Other stipulations may also be attached to the bond issue, such
              as the obligation for the issuer to provide certain information to the bond holder, or limitations
              on the behavior of the issuer. Bonds are generally issued for a fixed term longer than ten years.
              There are different types bonds like fixed rate bonds, floating rate bonds, high yield bonds, zero
              coupon rate bonds etc but we are concerned with municipal bonds. The purpose of these
              bonds is to raise money and to fund infrastructure development.


              b. Reinvestment risk: When interest rates are declining, investors have to reinvest their
              interest income and any return of principal, whether scheduled or unscheduled, at lower
              prevailing rates.




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              Sub: Economics                                                             Topic: Financial Economics


              Inflation risk: Inflation causes tomorrow’s dollar to be worth less than today’s; in other words,
              it reduces the purchasing power of a bond investor’s future interest payments and principal,
              collectively known as “cash flows.” Inflation also leads to higher interest rates, which in turn
              leads to lower bond prices. Inflation-indexed securities such as Treasury Inflation Protection
              Securities (TIPS) are structured to remove inflation risk.



                                                          ** End of the Solution **


         ClassOf1 provides expert guidance to College, Graduate, and High school students on homework and assignment problems in
                       Math, Sciences, Finance, Marketing, Statistics, Economics, Engineering, and many other subjects.




                                                                www.classof1.com


*The Homework solutions from ClassOf1 are intended to help the student understand the approach to solving the problem and not for submitting the same in
                                                      lieu of your academic submissions for grades.

								
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