Identify the type of risks to which the Bond Funds are exposed to.

Like equity mutual funds, bond funds also have following risks. Interest Rate Risk: This risk relates to fluctuation in market value of Bond consequent upon the change in interest rate (YTM) as discussed in the chapter on Security Valuation. There is inverse relationship between market value of bond and interest rate. As interest rate goes up market value of Bond falls and vice versa. Credit Risk: This risk is similar to risk of default in repayment of loans or payment of interest or both by the borrowers of the funds. Thus, this risk takes place when a Mutual Fund invested money in the Bonds of a company which defaults in the payment of Interest or Principal. This risk is higher in case of companies with lower Credit Rating. Prepayment Risk: This risk is related to early refund of money by the issuer of Bonds before the date of maturity. This generally happens in case of falling interest rates when a company who already issued Bond at higher interest rate issues fresh Bonds at lower rate of interest exercising its right of early redemption of Callable Bonds and refunding the money raised out of fresh issue. Reinvestment Risk: In a falling interest rate scenario, on maturity of the Bonds on its due date, the maturity proceeds get invested at a lower rate of interest. This brings down the overall yield of the Portfolio. This is known as a Reinvestment Risk. This turns out to be favourable in a rising interest rate scenario.