What are the primary risk factors associated with bond indexing?

The primary risk factors associated with bond indexing primarily revolve around duration and convexity. Duration measures a bond's sensitivity to changes in interest rates; it indicates how much the price of a bond is expected to change when interest rates move. Convexity, on the other hand, refers to the curvature in the relationship between bond prices and interest rates, highlighting how the duration of a bond changes as interest rates fluctuate.

In the context of bond indexing, these two factors are critical because they help investors understand the price volatility of their bond portfolio in response to interest rate changes. An indexed bond portfolio typically aims to replicate a bond index, and therefore, maintaining an appropriate level of duration and convexity is vital to effectively manage the risk associated with price movements due to interest rate changes. If the duration and convexity are not well-aligned with the index being tracked, the performance of the indexed portfolio could diverge from the index itself, leading to tracking errors.

While currency fluctuations, market demand and supply, and inflation rates are indeed relevant risk considerations in fixed income investing, they are not the primary focus for bond indexing. Currency risk becomes pertinent when bonds are issued in foreign currencies, potentially impacting returns for investors in different currency zones. Market demand and supply affect