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Recall that a bond is an instrument of debt, with the issuer being the borrower and the holder being the lender.
One advantage that bonds have over stocks is that they have relatively low volatility in terms of price. This means that the shift in price changes for bonds is usually smaller than that of stocks. Due to this, they seem to be a safer, more conservative investment. Also, because there is some relative certainty that the fixed interest payment twice a year will happen along with the fixed interest payment at maturity, bonds can be very attractive.
This attraction is also related to the fact that there is an element of legal protection that is present with bonds. If the bond issuer goes bankrupt, bondholders usually receive some money back during the recovery process. The company's stockholders end up with nothing.
The third advantage is that bonds are usually very liquid. It's easy for a financial institution that has invested heavily in bonds to sell a substantial quantity of them without moving the price. This is much more difficult to do with stocks.
Finally, because finance is an area in which new products are created to fulfill almost every need, there is usually a type of bond available to meet the different needs of investors, including zero-coupon bonds, convertible bonds, and floating-rate bonds, to name a few.
Bonds are subject to various types of risk.
One type of risk is interest rate risk. Bonds that have fixed coupon rates – and this is most of them – are subject to interest rate risk. Since the coupon payments are fixed, when market interest rates rise, the price of the bond will fall. This tells us that investors will be able to get a higher interest rate on their money somewhere else in the market. Perhaps they will invest in a newly issued bond that reflects the higher interest rate.
Bonds are also subject to repayment risk. This is for bonds that are callable. There's the risk that a bondholder's specific bond will be called for early repayment by the issuer.
There is also credit rating risk on the part of the issuer. If a credit rating agency downgrades its rating of the issuer, the market price of the bond will fall. And just as we saw with interest rate risk, it doesn't affect the interest payments, but it does affect the price. This would affect the holders of these bonds who may be seeking to sell them.
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