interest rate risk
The risk that changes in interest rates will negatively affect the value of investments, particularly bonds — when rates rise, bond prices fall.
Example
“Long-term bond holders faced severe interest rate risk in 2022 as the Fed's rate hikes caused bond prices to plummet.”
Memory Tip
Interest rate RISK = rising rates HURT bond prices. Longer duration = more risk.
Why It Matters
Interest rate risk directly affects your investment returns and the value of your savings. Understanding this risk helps you make better decisions about where to keep your money and how to protect your portfolio when economic conditions change.
Common Misconception
Many people think that bonds are always safe investments with guaranteed returns. In reality, while the interest payments are guaranteed, the market value of the bond fluctuates with interest rates, meaning you could lose money if you need to sell before maturity.
In Practice
Suppose you buy a 10-year government bond paying 3 percent annual interest when rates are at 3 percent. If interest rates rise to 5 percent the next year, newly issued bonds will pay 5 percent, making your 3 percent bond less attractive. If you need to sell your bond before maturity, you will have to sell it at a discount to compensate buyers for the lower interest rate.
Etymology
INTEREST RATE (cost of borrowing) RISK (potential for loss). The RISK from INTEREST RATE changes.
Common Misspellings
Protect your assets with the right insurance
Related Terms
More in risk management
Other risk management terms you should know
See Also
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