Bond Investment Risk - How Do I Measure It? 

The measurement of bond investment risk is relatively easy in comparison with other types of investments. This is because bonds possess fixed characteristics that other investments do not offer. Thus, you will find that bonds have fixed par values, coupon rates and maturity periods stated on the certificates.

Bond Investment Risk - Prices and Yields

You need not be a math genius to figure out the bond prices and yields on whatever bonds issue you are thinking of purchasing. Just make sure that you know the three abovementioned data to start on the computation.

Bond prices are quoted on the certificate as a percentage of its face value. If a bond is trading at 103, then its trading price is 3% above its par value. Let's assume that the bond denomination is $1,000 at par, which means that its purchase price is $1,020.

But if a bond is selling at a discount - this is the more common scenario so that the purchaser will end up with a positive yield at the end of the maturity period, thus further lessening the bond investment risk - then just multiply the par value with the quote. For example, if the same $1,000 bond is selling at a discount of 99, then its purchase price will be $990 (1,000 x .99)

Bond yields have an inverse relationship with bond prices. Obviously, when the yields rise, the prices will fall. This is because new bonds that pay higher interests can now be bought with the same amount of money.

For example, you bought a $1,000 5-year bond with a 5% interest rate. The following year, interests rose to 6%. Your bond will now be worth less than what you paid for it last year.

Bond Investment Risk Factors

When you know the basic computations for bond risks and bond yields, then you are better able to calculate the bond investment risk. These concepts are all related, which is also true for all other investment types like stocks.

Keep in mind that every bond issue carries a certain degree of risk that the obligor will be unable to pay the principal plus the interest amount on time. It may also be that the issuer can delay on the payment of interest but pay the principal on time.

Many factors come into play when measuring the bond investment risk for a certain issue. These factors include but are not limited to:

• Maturity Period - Obviously, events 10 years from now are more unpredictable than events 1 year from the bond purchase. Many issuers will offer high interest rates on long-term bonds to attract investors and, thus, offset the risks associated with longer maturity periods. The most common way to measure price changes for bonds is duration, which is simply the weighted average of the bond payments' present value.
• Bond Rating - Credit rating agencies like Moody's and Standard & Poor's provide for the most reliable measure of how well the issuer can pay its obligations. Thus, AAA-rated bonds are prime grade investments while the so-called junk bonds are high-risk propositions that only the most experienced investors will dabble in.

In the end, the calculation of bond investment risk should not cause sweating on your part. Often, all you have to do is to look at the bond rating and you already have an almost-complete estimation of the risks involved.