Short Selling: A Risky Bet

 The most obvious risk that fixed-income investors face is that of. The other, less obvious, is the risk that the volatility of the fixed-income markets—which increased substantially in the wake of the financial crisis of 2008—will continue to disrupt the markets and thwart investors’ return on their investments.

will be hurt by rising interest rates is often understated. Since the early 1980s, the yield on U.S. ten-year bonds has more than tripled, and interest rates have risen even higher since then. The effect on investors has been immediate and painful. After a brief period of calm in the early 1980s, during which interest rates fell, investors began to panic when the yield on ten-year bonds surged.

Fixed-income securities are subject to interest rates and credit risk. They are also subject to inflation risk, which is the risk that the price level will rise over time because of higher inflation.

a short sell

short selling. A short is a bet that a share, bond, Treasury note, or commodity—in short, any financial instrument—will decline in value.

a short sell. This means that an investor expects the market price of a security to fall. As a result, a short seller may need to borrow shares from a broker or other lender and sell them in the market before repurchasing them at a lower price.

losing their principal in a short sale. In a short sale, an investor borrows money against an asset, sells that asset, and then loans the money back to the original lender.

a declining principal. To some extent, investors can mitigate this risk by investing in fixed-income securities with yields that are lower than the yields on other fixed-income securities. Yields can be lowered by purchasing bonds with strings attached, such as call protection, which gives investors the option of getting their principal back if they exercise the option before the maturity date of the bond. Counter-party risk, in which another party suffers if the two parties do not perform their obligations, is another risk that fixed-income investors face.

losing principal, which can lead to significant losses. A fixed-income investor, particularly one who borrows money at low-interest rates, can also lose interest and principal. For this reason, fixed-income investors should avoid significant fixed-income investments unless they are highly confident that they understand the risks.

The risk that investors, especially those with a longer-term horizon.

Over the long term, it is difficult to say whether fixed-income volatility and risk will continue; if they do, then the risk-reward tradeoff for investors will be quite unfavorable. In the short term, though, fixed-income investors will not be disadvantaged. The futures market is extremely liquid, and investors will be able to easily short fixed-income securities or long them should the view become more bearish. So, the short-term risks to fixed-income investors are limited.

…should brace themselves for, is that of fixed-income turmoil. Volatility in government interest rates has been an on-and-off feature of financial markets since their inception in the 19th century, but those days are gone. In their place, we have seen a long string of periods of historically low volatility, punctuated by bursts of the sudden and dramatic increase. It… is increasingly difficult for fixed-income investors to identify turning points, and the financial markets—particularly interest-rate derivatives—have been unstable enough that many people have been reduced to panicking about some possible point of no return

fixed-income markets will be disrupted is real. It is a risk that investors should be aware of before investing. Macroeconomic conditions, including inflation, interest rate, and exchange rate volatility, remain volatile as a result of the Covid-19 pandemic and the hand of uncertainty over how to restart global economies, Investors should keep a watchful eye on the strength of their banks and financial institutions, as well as on the U.S. economy and political environment to assess their exposure to risks that may affect them.

fixed-income investments will experience volatility as businesses in other countries fall into distress and cut share prices which is very real. In such situations, fixed-income investments become more or less a gamble—and, for the most part, the only sure thing is that you’ll lose your money. Because of this, fixed-income investment risks should be seriously considered before investing in them. The volatility that fixed-income investors see is not nearly as pronounced as the volatility they would see from stocks, but it’s still real.