Interest rate risk is the uncertainty associated with changes in the price of a bond caused by changes in the general interest rate levels in the economy. Since coupon payments are fixed, if general interest rates fall, bond prices increase. If interest rates rise, bond prices fall. However, if the bondholder is holding the bond to maturity, he is insulated from this interest rate risk.
EXAMPLEIf a bondholder is holding a bond paying a 6% coupon and general interest rates fall, he will continue to receive 6% coupon payments.
The other side of the coin is reinvestment risk. Reinvestment risk is the uncertainty that the holder will be able to reinvest his funds at the same rate, or better rate, at maturity.
If a bond is callable and interest rates fall, it is more likely that the issuer will call the bond while the holder is enjoying the higher fixed coupon payment. This shows that reinvestment risk and interest rate risk are inversely related. An investor could moderate one or the other, but they cannot eliminate both.
The default risk is the risk that the bond issuer will not make payments as scheduled. If payments are missed and it goes bankrupt, investors may lose much, if not all, of their money.
In bankruptcy, bank lenders are very high in the precedence of being paid back from liquidation. Bondholders have precedence over equity holders and have a certain amount of legal protection. If a company goes bankrupt, its bondholders will often receive some money back. The company's common stockholders usually end up with nothing.
When a company can't pay its obligations, it enters bankruptcy court. There are two types of bankruptcy for which a corporation can file:
Source: THIS CONTENT HAS BEEN ADAPTED FROM LUMEN LEARNING'S “Bond Risk” TUTORIAL.