1. Diversification: Diversification can help reduce the overall risk of a corporate bond portfolio. Investors should consider buying bonds of companies across different sectors and geographies, with different credit ratings and maturities.
2. Credit ratings: Investors should look at credit ratings provided by rating agencies to assess the default risk of a corporate bond. Generally, the higher the credit rating, the lower the risk of default.
3. Bond covenants: Bond covenants are legal restrictions and obligations that a borrower has to abide by. These covenants can include minimum liquidity and cash flow ratios, limits on dividend payouts and asset sales, and restrictions on additional borrowing. These covenants can provide an additional layer of protection for bondholders.
4. Bond insurance: Bond insurance can protect investors from default risk. Bond insurance companies guarantee payment of interest and principal in the event of default by the issuer. Some issuers also offer a credit enhancement mechanism in the form of a standby letter of credit, which provides a guarantee that the issuer will repay the bondholders if it defaults.
5. Fundamental analysis: Investors should conduct fundamental analysis of the issuer to understand the financial health of the company, its business operations, and long-term prospects. This can help investors determine the likelihood of default and assess whether the current bond price represents a good value.
6. Monitoring: Regular monitoring of the corporate bonds in a portfolio is essential to managing default risk. This can involve monitoring the issuer’s financial statements, changes in credit ratings, and news related to the company’s operations and industry. Any signs of financial distress or deterioration should be addressed immediately.
