NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Investing in Fixed Income Securities (NISM XXI-A)
Which of the following is the main risk faced by a bond investor when market interest rates rise, even if the issuer is certain to pay all dues?
The main risk is interest rate risk. When market rates rise, the prices of existing fixed-coupon bonds fall because new bonds offer higher yields, even when the issuer is certain to meet every payment.
- ACredit risk, because the issuer's rating falls automatically
- BInterest rate risk, because the market price of existing fixed-rate bonds fallsCorrect
- CReinvestment risk on the principal at maturity only
- DLiquidity risk, because coupons stop being paid
Explanation
When market yields rise, existing bonds with lower fixed coupons become less attractive and their prices fall. This is interest rate (price) risk. It is independent of credit quality, and coupons continue to be paid.
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