Chartered Institute of Stockbrokers (CISI) Professional Practice Exam

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What is the primary risk associated with owning a bond?

Liquidity risk
Credit risk
Market risk from interest rate changes
Operational risk

The correct answer is: Market risk from interest rate changes

Owning a bond primarily exposes an investor to market risk, particularly risk associated with changes in interest rates. When interest rates rise, the market value of existing bonds typically falls because newer bonds are issued with higher yields, making older bonds with lower yields less attractive in comparison. This inversely proportional relationship means that if an investor holds a bond until maturity, they may not face this risk directly, but if they need to sell the bond before maturity, the market price may be adversely affected by rising interest rates. Understanding market risk in relation to bond investing is essential, as it greatly influences both the valuation of the bond portfolio and the investor's strategy. While factors like liquidity risk, credit risk, and operational risk are important considerations in the broader investment landscape, they do not primarily characterize the main risk faced by bondholders in the context given, which is how interest rate fluctuations impact a bond’s market price.