This note was written by Frederico Rossi.
In this note we will discuss the risks these debt instruments present. We will then appoint and explain each of the main risks in the investment of bonds.1- Interest rate risk
The interest rate and the prices of the bonds have an inverse relationship, since while the low rate, the price of the bonds on the suben market and vice versa. Therefore, when reference interest rates start to rise the bonus price will start to fall.In addition, when this occurs the opportunity cost of maintaining a portfolio bonus, it is reduced, since the market can get higher rates by changing the old bonus for a more attractive new one. This pressure on the sale of the old bonus reduces its price and at the same time increases its internal rate of return (TIR).
2- Default risk
This is a risk that any Argentine investor certainly at some point suffered. Basically, there is the possibility that the debt issuer is unable to repay it (default) or any different reason (for example, lack of will), the creditor does not receive the promised (technical default).3 Reverse risk
By investing in bonds, the most relevant variable is the internal rate of return (TIR) since it computes the expected annual return of the bonus taking into account, in addition to the coupon, the gain or loss of capital depending on the current market price. However, the calculation of the TIR presupposes that all interim payments to maturity are reinvested at the same rate.But in practice, if interest rates fall in the future, the intermediate payments received will be reinvested at a lower rate, thereby reducing the effective rate. So the risk of reinvestment is the risk of having to reinvest payments received at a rate lower than that previously received.
4- Risk of inflation
This type of risk has to do with the increased cost of living during the period the investor has the bonus. If the cost of living or otherwise the cost of inflation increases at a higher rate than the investment of the bonus, the investor may decrease its purchasing power and even get a negative return when considering inflation.For this reason, usually in Argentina, the government issues obligations linked to certain variables such as dollar-linked, CER, Badlar or directly debt denominated in foreign currency, since the risk of inflation is so high that a fixed rate issue in weights and a long term is unreliable.
5 Currency risk
This risk is present in investments made in foreign currency. When you acquire a title named in foreign currency, the investor knows in advance how much you will receive, but does not know what the exchange rate will be in the future.6- Risk of liquidity
This risk has to do with the ease of converting this asset into cash. The liquidity of any bonus is linked to the size of an issue or market. While more child is the market, or lower the amount issued, more difficult will be to find a buyer.The little interest in a particular bond issue can lead to great price volatility and this can have an adverse impact on total income when the investor wants to sell the bonus. Generally, if the spread (difference) between the value of the seller tip and the value of the buyer tip is large, you may suspect a liquidity problem.
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