The Riskiness of Governments and Corporate Bonds

Question: Discuss about the Riskiness of Governments and Corporate Bonds. Answer: Introduction Governments bonds or corporate bonds are loans to the government or the company respectively. The decision to loan to these parties is based on the risk involved. Thus, the buyers of the bond are attracted to bonds with the highest returns. This is irrespective of the possibility of risk. If two different bonds are giving the same yield, the investors only concern when making a decision is that of the quantity of risk involved. Safeness of Government Bonds When it comes to government bonds, these are the safest investments. The explanation for this is that; the investor is assured that the full loan amount will be repayable after the maturity period. In comparison to the company bonds, buying company bonds may result in the investors losing their money in case there was a companys bust. O'Shea (2017) noted that the government in case it runs out of money would control its currency and can print money so that it pays its obligations. He also stated that the return on the government bonds is on a risk free rate. There is zero probability of default on government bonds (Conley, 2016). Thus, even if the rate of a governments bond falls slightly below that offered by a company, a rational investor would still go for the governments bond. Now lets consider the short run case. OShea noted that the governments bond are the most risky in the short run. These bonds are considered risk free on the assumption they are held till maturity (Kenny, 2017). This is because an increment in interest rate would result in a fall in the bond prices. If interest rate rises by a units, the fall in price would be very high. If the bonds were to be cashed after such a change, the value would be lower. Thus, the government bonds are faced by risk if the current interest rate is low. For these bonds to be risk free both in the short and in the long run, the interest rate must be currently high. In addition to the interest rate risk, Conley (2016) also noted the risks of inflation and opportunity cost. High inflation rate lowers the value of treasury investments and opportunity cost is incurred since other investments with a higher return are disregarded. The Riskiness of Corporate Bonds Unlike the government bonds, there are many other risk factors facing the corporate bonds. There are far away from being risk free. They are considered the most risky bonds. In additional to the risk factors of interest rate and inflation rate experienced in both the government and corporate bonds, there are several other risk factors for the latter. One is the risk of credit/default; there is the possibility that the company may fail to pay back the investors money. Curtis (2017) noted that many investors are not aware that the governments full faith and credit does not guarantee the corporate bonds. Instead, they are guaranteed by the ability of the company to pay the debt. Therefore, investors should use the coverage ratio to determine the possibility of default. A higher ration deems the investment to be safe. Two, the rating downgrades; if a company is rated low in its debt repayment, interest rate charged on future loans by lending agencies and banks goes up (Lo?ffler and Posch, 2011). For this case, the ability of a company to satisfy its debts is adversely impacted. Three, liquidity risk owing to the market for corporate bonds being so thin and thus the ability to sell the bonds quickly is reduced. Four, the call risk; where the bond issuer may repurchase the bond for instance in interest rate goes to low (Langager, 2017). Conclusion Low interest government bonds taken for a long term are risky although they would be labelled risk free. Any investor who is about to make the decision to invest on government bonds should consider the interest rate factor. When the interest rate is low, its expected to rise, but when it is very high, it is guaranteed it will come down after some time since a high interest rate is not sustainable in an economy. A fall in interest rate makes the bond prices to rise. Therefore, the investment is good with high interest rate. Investors to corporate bonds should first determine the possibility of default before initiating the investment. There are higher risks associated with corporate bonds. References Conley, P. (2016). Are Treasuries Really the Safest Investment? [Online] The Balance. Available at: https://www.thebalance.com/what-is-the-safest-investment-417037 [Accessed 7 Apr. 2017]. Curtis, G. (2017). Six Biggest Bond Risks. [Online] Investopedia. Available at: https://www.investopedia.com/articles/bonds/08/bond-risks.asp [Accessed 8 Apr. 2017]. Kenny, T. (2017). What Types of Bonds Feature Low Risk? [Online] The Balance. Available at: https://www.thebalance.com/lowest-risk-bonds-what-types-of-bonds-are-the-safest-417025 [Accessed 7 Apr. 2017]. Langager, C. (2017). What are the risks of investing in a bond? [Online] Investopedia. Available at: https://www.investopedia.com/ask/answers/05/bondrisks.asp [Accessed 8 Apr. 2017]. Lo?ffler, G. and Posch, P. (2011). Credit risk modeling using Excel and VBA, second edition. 1st ed. Chichester, West Sussex, U.K.: John Wiley Sons Ltd. O'Shea, T. (2017). Are Governments Bonds Safe? [Online] timoshea.co.uk. Available at: https://www.timoshea.co.uk/are-governments-bonds-safe/ [Accessed 7 Apr. 2017].