Explain four types of risks in which bonds are exposed to?

1. Interest rate risk: Bonds are exposed to interest rate risk, which is the risk that changes in interest rates will affect the value of the bond. When interest rates rise, the value of existing bonds decreases, as investors can earn higher returns by investing in new bonds with higher interest rates. Conversely, when interest rates fall, the value of existing bonds increases, as they offer higher returns than new bonds with lower interest rates.

2. Credit risk: Bonds are also exposed to credit risk, which is the risk that the issuer of the bond will default on its payments. This risk is higher for bonds issued by companies with lower credit ratings, as they are more likely to default on their debt obligations. Investors can mitigate credit risk by investing in bonds issued by governments or companies with high credit ratings.

3. Inflation risk: Bonds are exposed to inflation risk, which is the risk that inflation will erode the purchasing power of the bond's future cash flows. Inflation reduces the real value of fixed interest payments, making them less valuable in terms of purchasing power. Investors can mitigate inflation risk by investing in inflation-protected bonds, which adjust their interest payments based on changes in the inflation rate.

4. Liquidity risk: Bonds are exposed to liquidity risk, which is the risk that investors may not be able to sell their bonds quickly and at a fair price. Bonds with lower liquidity may have wider bid-ask spreads and may be subject to price fluctuations due to changes in market conditions. Investors can mitigate liquidity risk by investing in bonds with higher trading volumes and by diversifying their bond holdings.