Bond Risk & Investor Profile — Q&A

Interest income — a legal obligation of the issuer paid semi-annually without BOD approval. Missing payments can trigger lawsuits and bankruptcy. Dividends require board approval and are less predictable.

Interest rate risk — long maturities, low coupons (also affects preferred stock). Purchasing power (inflation) risk — longer maturities; mitigated by short-term securities.

When inflation rises, the Federal Reserve often raises interest rates to slow demand — and when rates rise, bond market prices fall. Both risks increase with longer maturities.

Investment grade: BBB (Baa for Moody’s) or higher — little to no default risk. Speculative/junk: BB (Ba for Moody’s) or lower — considerable default risk increasing as ratings fall.

Standard & Poor’s (S&P), Moody’s, and Fitch. All focus exclusively on default risk.

Liquidity (marketability) risk — trading often stays within local buyers due to tax-free status; smaller municipalities have fewer potential buyers. Also higher default risk for revenue bonds versus G.O. bonds.

When a callable bond is called (typically as rates fall), the investor must reinvest both interest AND the returned principal at lower rates — a larger amount affected than reinvesting coupon payments alone.

An investor’s age roughly matches the percentage of bonds in their portfolio (e.g., age 60 → ~60% bonds). It is a general guideline, not absolute — wealthy or risk-tolerant seniors may hold more stocks; conservative young investors may hold more bonds.

When an investor wants a predictable payout at a future date (college savings, retirement) but does not need income along the way — long-term goal funding with no interim cash flow requirement.

Bond investors tend to be older, more conservative, seeking predictable income. Bonds carry less risk than common stock (legal interest obligation) and therefore offer lower expected returns. Not all bonds are safe — junk bonds carry significant default risk with higher yields.