Definition
Interest rate risk is the primary risk for most fixed-income investments. Bond prices move inversely with rates—when rates rise, existing bonds with fixed coupons become less attractive, pushing prices down. Duration quantifies this sensitivity. The risk is greatest for long-duration, low-coupon bonds. Floating-rate notes largely eliminate interest rate risk.
lightbulb Example
A portfolio of 30-year Treasury bonds with duration of 20 years. If rates rise 1%, the portfolio loses approximately 20% of its value. In 2022, the Bloomberg Aggregate Bond Index fell 13% as the Fed rapidly raised rates.
verified_user Key Points
- Primary risk for fixed-income investors
- Longer duration = greater interest rate risk
- Floating-rate instruments mitigate this risk
- Duration measures the sensitivity