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RisksAssociatedwithFixed

IncomeSecuri8es

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ReturnComponents

Returnobtainedfrominves8nginafixedincomesecurityfromthedayitispurchased

tothedayitissoldhastwocomponents:

ChangeinmarketvalueCashflowsreceivedfromthesecurityduringthe8meitisheld,plusaddi8onalincomefrom

reinvestmentofthesecashflows

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RisksAssociatedwithFixedIncome

Investments Market,orinterestraterisk Reinvestmentrisk Timing,orcall,risk Credit,ordefault,risk Yieldcurve,ormaturity,risk Infla8on,orpurchasingpower,risk Liquidityrisk Exchangerate,orcurrency,risk

Vola8lityrisk Poli8calorlegalrisk

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InterestRateRisk

Mostimportantriskformostfixedincomeinvestors.

Usually,thevalueofafixedincomesecuritydecreasesasinterestratesrise.

Sellingwhenrateshaverisenwillresultinaloss. Thereareexcep8ons(e.g.putop8ons). Domes8ctreasuryyieldcurveismostcommonbenchmarkformeasuringratechanges.

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ReinvestmentRisk

Returnearnedwhenreinves8ngthecashflowsofafixedincomesecuritydependson

theprevailingmarketrateswhenthosecash

flowsarereceived. Theriskisthatrateswillbelowwhencashflowsbecomeavailableforreinvestment.

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Timing/CallRisk

Ifthefixedincomesecurityhasacallprovision,thecashflowsreceivedareuncertain.

Callfeaturesexacerbaterevinvestmentrisk:Bondswilltendtobecalledwheninterestratesarelow(issuercangetcheaperfundingbyrefinancing).

Aversionofthisriskistheprepaymentriskofmortgagebackedsecuri8es.

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CreditRisk

Riskduetoachangeinthecreditworthinessoftheissuer.

DefaultriskRecoveryrisk

Migra8onrisk Spreadrisk(oenconsideredapartofmarketrisk).

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TreasuryEurodollar Spread (TED Spread)

Source:Wikipedia

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YieldCurve/MaturityRisk

Theyieldcurvereferstothecurrentmarketinforma8ongivingtheyieldtomaturityforbondsofdifferentdura8ons.

Itcanbeusedtomakeassump8onsaboutthefuturebehaviourofinterestrates.

Investmentdecisionsmaybemadebasedonapar8cularassump8ononthebehaviouroftheyieldcurve.Theobtainedreturnwillbeaffectedbydevia8onsof

actualinterestratesthatprevailinthefuturefromthoseinferredfromthecurrentyieldcurve.

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Infla8onRisk

Infla8onaffectsthevalueoffuturecashflows,whenmeasuredintermsofpurchasingpower.

Unlessthebondisinfla8onlinked,theholderhasanexposuretothisrisk.

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LiquidityRisk

FlighttoqualityscenariosInvestorsrushtothesafestpossiblesecuri8es(e.g.U.S.treasuries)

Pricesofallothersecuri8esdropdrama8callyE.g.AugustSeptember199,September200

Wideningbidaskspreads(highertransac8onscostsduetolowerliquidity).

Fundingliquidityrisk(illiquidvs.insolvent).

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ExchangeRateRisk

Receivingcashflows(e.g.fromholdingabond)inacurrencyotherthanthedomes8c

currencyexposesaninvestortoexchangerate

risk. Holdingbondsissuedinanothercountryalsoexposesaninvestortotheinterestraterisk

fromthatcountry.

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Vola8lityRisk

Interestratevola8lityaffectsthevalueofop8onsembeddedinbonds(e.g.callable,putablebonds,prepaymentop8onsembeddedinmortgagebackedsecuri8es).

Thevalueoftheseop8onsincreaseswithincreasingratevola8lity.

Iftheseop8onsaregrantedtotheissuer(asincallablebonds,MBS)thepriceofthesecuritywilldecreasewhenvola8lityincreases.

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Poli8cal/LegalRisk

Taxpolicy Abilitytoenforcebondcovenants Legalstatusofthedebt(e.g.withinbankruptcy,restructuring)

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EventandSectorRisk

EventRisk:Theabilityofanissuertomeetitsobliga8onsmightbeaffectedbyaseriousand

unexpectedchangeduetoasuddenevent.

NaturalorindustrialaccidentTakeoverorcorporaterestructuring

SectorRisk:Riskduetothepossibilityofadversedifferen8almovementsofspecific

sectorsofthemarket.