What is interest rate risk?

Interest rate risk refers specifically to the potential for changes in bond values as a result of fluctuations in interest rates. When interest rates rise, existing bonds with lower rates become less attractive, causing their market values to decline. Conversely, if interest rates fall, existing bonds with higher rates become more appealing, increasing their value. This risk is particularly pertinent for bond investors, as their investments are directly impacted by these interest rate shifts. Recognizing how interest rate risk operates is crucial for financial managers and investors alike because it affects the overall valuation of fixed-income securities in a portfolio. Understanding this risk allows investors and managers to make informed decisions about bond investments and hedging strategies to mitigate potential losses from interest rate fluctuations.