Smart Bond Investing—Types of Bonds

International and Emerging Markets Bonds

Just as you can buy bonds from the U.S. government and U.S. companies, you can purchase bonds issued by foreign governments and companies. Since interest rate movements may differ from country to country, international bonds are another way to diversify your portfolio. Since information is often less reliable and more difficult to obtain, you risk making decisions on incomplete or inaccurate information.

International bonds expose you to a mixture of risks that are different for each country. A country's unique set of risks is known collectively as sovereign risk. A nation's political, cultural, environmental and economic characteristics are all facets of sovereign risk. Unlike Treasuries, which carry essentially zero default risk, default risk is real in emerging markets, where the sovereign risk (such as political instability) could result in the country defaulting on its debt.

Furthermore, investing internationally also exposes you to currency risk. Simply stated, this is the risk that a change in the exchange rate between the currency in which your bond is issued—euros, say—and the U.S. dollar can increase or decrease your investment return. Because an international bond trades and pays interest in the local currency, when you sell your bond or receive interest payments, you will need to convert the cash you receive into U.S. dollars.

International Bond Risk Report Card   Credit and default risk: Varies significantly from bond to bond and is sometimes hard to determine.   Liquidity risk: As with many U.S. corporate bonds, it can be difficult to find a buyer for an international government or corporate bond.   Currency risk: The risk that a change in the price of the U.S. dollar or currency of the country in which the bond is issued will have a negative impact on return.   Interest rate risk: If interest rates rise, the value of an international bond on the secondary market will likely fall.   Event risk: Mergers, acquisitions and other tumultuous events can have a negative impact on a bond issuer's ability to pay its creditors.