What are three main risks of investing in bonds?

• A. Credit, currency, and market risk.
• B. Liquidity, political, and tax risk.
• C. Interest rate risk, credit/default risk, and inflation risk.
• D. Reinvestment risk, liquidity risk, and currency risk.

Answer: (C)

Bonds expose investors to several risks, with three commonly viewed as the main ones: interest rate risk, credit risk, and inflation risk.

Interest rate risk comes from the inverse relationship between bond prices and prevailing rates. When rates rise, existing bond prices typically fall, especially for longer maturities, because new bonds offer higher yields. If you need to sell before maturity or compare returns, rising rates can erode the value of your investment.

Credit risk, or default risk, is the chance the issuer won’t make scheduled interest payments or repay principal at maturity. Higher credit risk usually means a higher potential yield, but also a greater chance of losing money.

Inflation risk is the threat that rising prices will erode the purchasing power of the bond’s fixed payments. Even if you receive all interest and principal, those dollars may buy less over time if inflation accelerates.

Other risks like currency risk, liquidity risk, or reinvestment risk exist in certain scenarios, but the trio above is the most fundamental way bond investing can be affected across many common bond investments.