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Bonds carry two distinct risks: their market prices can fall when interest rates rise, and their issuers can fail to make promised payments. The first is interest-rate risk; the second is credit risk. Understanding the difference helps you compare bonds and judge how much a possible early sale matters.
How do interest-rate and credit risk differ?
A bond is a debt security: its issuer promises interest payments and repayment of face value at maturity, subject to the bond’s terms and the issuer’s ability to pay. Issuers include governments, municipalities, and corporations. SEC Investor.gov explains bond basics and risks.
| Risk | What can go wrong | What it affects |
|---|---|---|
| Interest-rate risk | Market rates change, shifting the value of existing bonds. | The price you may receive if you sell before maturity. |
| Credit risk | The issuer cannot or does not make interest or principal payments as promised. | Whether you receive the bond’s scheduled cash flows. |
The risks can occur together. A bond from a financially strong issuer can still lose market value when rates rise; a bond with greater default risk may offer a higher yield, but that does not remove the possibility of missed payments.
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Generally, yes—if you sell before maturity. When market rates rise, newly issued fixed-rate bonds may offer more attractive interest, so the prices of existing fixed-rate bonds generally fall. When rates fall, those prices generally rise. The SEC describes this as a fundamental relationship in its June 26, 2013 Investor Bulletin.
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The SEC’s hypothetical example shows a $1,000-face-value bond with a 3% coupon and 10 years to maturity priced at $925 one year later after market rates rise from 3% to 4%, with nine years remaining. This is an illustrative price after a one-percentage-point rate increase—not a market statistic or forecast.
Rate sensitivity is generally greater for bonds with longer maturities than for shorter-maturity bonds of similar credit quality. Lower-coupon bonds are also generally more sensitive when other features are similar. Duration can help express a bond’s sensitivity to rate changes, but an estimate for any particular bond depends on its terms.
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Does holding a bond to maturity remove interest-rate risk?
Holding an individual bond until maturity can make interim price movements less important if you do not need to sell and the issuer pays as promised. It does not guarantee a profit or remove credit risk. If you sell early, the price may be above or below face value; a government guarantee of payments under a bond’s terms does not guarantee the price you will receive in an early sale.
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No. Credit ratings are assessments of relative credit risk, not promises of payment. They can change, and a highly rated bond can still default. Investor.gov says ratings “seek to estimate the relative credit risk of a bond as compared to other bonds,” while a high rating does not mean there is no chance of default. Read Investor.gov’s municipal bond overview for that distinction.
For corporate bonds, the issuer’s financial condition and the bond’s terms matter. Indentures may include covenants, such as limits on additional borrowing or requirements to maintain financial ratios. High-yield corporate bonds generally carry greater default risk than investment-grade bonds; a higher coupon or yield should not be assumed to offset a potential loss. See Investor.gov’s overview of corporate bonds.
How should I compare two bonds?
Compare like with like where possible, and look beyond the advertised yield. Relevant factors include:
- Rate sensitivity: Compare maturity and coupon; duration may help show how prices could respond to rate changes.
- Credit quality: Consider the issuer’s ability to pay, its rating and any rating changes, and the bond’s covenants and other terms.
- Price and cash flows: Review the purchase price, coupon, yield to maturity, and whether you may need to sell before maturity.
- Liquidity: Consider how readily the bond can be sold at a price that reflects its value.
- Structure: An individual bond has a stated maturity; a bond fund holds a changing portfolio and exposes shareholders to fund-level interest-rate and credit risks.
Yield is only one part of the comparison. A higher offered rate may reflect greater credit risk, less liquidity, or other bond features—not a guaranteed increase in return. For municipal bonds, tax treatment depends on jurisdiction and personal circumstances; the available information does not establish an individual tax outcome.
What changes when I invest through a bond fund?
Bond funds also face interest-rate and credit risk. Unlike an individual bond, a fund holds a portfolio that can change, so its shareholders are exposed to the fund’s ongoing holdings rather than one bond’s stated maturity and repayment terms. Review the fund’s current prospectus and shareholder report, including its maturity or duration profile and credit exposure. SEC guidance is available in Investor.gov’s bond funds overview.
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