It’s often said that government bonds represent one of the lowest possible risks for an investor. In general, true - but much depends on which government issues them and which investor is buying.

Government bonds are usually sold with the wording ‘Backed by the full faith and credit of the…’ So, estimating the risk becomes an exercise in determining how much faith one places in that credit.

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First, a confession: Interest rates are unpredictable. But then, you knew that already. Fortunately, they’re not entirely unpredictable. Good bets are possible.

But before discussing some of the factors influencing them, a few words about why you should care: Price-Yield correlation. Which means what, now? As interest rates rise, bond prices fall. When rates fall, prices rise. Common sense reveals the reason.

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‘Junk’ bonds - more politely known as high-yield bonds - acquired the name as a consequence of their low rating by the major agencies and their high rate of default. ‘Default’ is the failure to repay principal and/or suspension of interest payments.

But a curious thing happened in the 1980s. Michael Milken examined the market carefully and determined that the default rate was unlikely to be as high on certain bond issues than was previously thought. The ‘high-yield’ market was born.

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Every bond carries some risk that the issuer will default on repayment of the principal or suspend interest payments. Once that risk is measured (see ‘Measuring Risk’ elsewhere in this series), then what?

First, a review.

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Few investments offer as objective an estimate of risk as bonds.

Because of some fixed characteristics - par (face value, repaid at maturity), coupon (interest rate, percentage paid in semi-annual payments on the par) and maturity (date principal is repaid) - predicting bond values and risk with some confidence is as much science as art.

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One reason stocks are more popular than bonds is that the latter are more complicated. Ironic, considering their risk and returns bonds are easier to judge and predict with confidence.

Adding to the complexity are the differing tax issues affecting bond returns.

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