While stocks are "rated" or evaluated by Morningstar, Value Line, and others, bonds are rated as well, so prospective investors can assets the level of risk before buying. The three main bond rating agencies are Moody's, Standard & Poor's, and Fitch Ratings. Corporate, municipal, and international bonds are rated, but not Treasuries. They automatically receive the highest rating (AAA), since they have the government's "money-back" guarantee.
The lower the bond rating, the higher the risk and the interest rate. If you opt for a higher interest rate by buying a bond with a "B" rating, that means there's a possibility that the debtor may default, in which case you'd lose your original principal. A rating of "CCC" means an even higher interest rate, but it also signifies that a company or municipality may be on the cusp of defaulting. Risk can be its own reward, but it can also be an investor's downfall.
Risk: when bad things happen to good bonds
A number of factors affect the value of a bond: the state of the economy, supply and demand and the bond issuer's stability. U.S. Treasuries and savings bonds are the only risk-free securities. When it comes to all the rest, you have to factor in:
Market risk. If interest rates rise, there may an overabundance of high-paying bonds, reducing the value of yours. Similarly, there's liquidity risk, meaning you may not be able to sell your bonds if interest rates aren't favorable.
Default risk. This is the risk that the issuer will become insolvent and default on payments.
Inflation risk. If inflation rises, the interest income and the principal you're paid back at maturity will buy less down the road than the same amount today. The longer the term, the greater the risk that inflation might eat away at your returns
Early call/Reinvestment risk. If the issuer exercises its call option prematurely, you may have to scramble to reinvest your money at attractive rates.
Then there's always the risk of unexpected events that could impact negatively on your investments such as calamities, war, changes in the tax laws, and so on.
