Investing in corporate bonds is not without risk, but it is, however, possible to assess this risk thanks, inter alia, to the ratings attributed by rating agencies.
The principal risks that apply to corporate bonds are the following:
- Insolvency risk: this is closely linked to the quality of the issuer. The ratings attributed by rating agencies give investors an idea of the financial health of the issuing company. The higher the rating, the lower the risk of default. Beware, however: no judgement is infallible. If the issuer defaults, the investor could lose every penny of the money he has invested.
- Liquidity risk: this depends on the existence and operation of a secondary market for the corporate bond. Basically, the higher the total amount of the issue, the more likely a higher volume of transactions, which reduces the counterparty risk.
- Exchange risk for corporate bonds issued in foreign currencies. Exchange risk means that on redemption the investor may receive an amount in euros that is less than the initial euro investment.
- Interest-rate risk: the price of a corporate bond fluctuates in line with market trends, full repayment only being assured at maturity.
To generate a higher return, an investor can diversify his corporate bond portfolio by including issuers with low ratings or that have no rating at all. He must then be aware of the fact that the risks to which he is exposed will also be higher, a higher yield generally going hand in hand with high volatility, and that if the issuer becomes insolvent, he could lose every penny he has invested. To manage the risk effectively, a private investor may resort to a bond fund, which provides him with broad diversification even with limited capital.