What does 'interest rate risk' refer to?

Interest rate risk specifically refers to the potential for investment loss that arises from fluctuations in interest rates. When interest rates change, the value of existing fixed-income investments, such as bonds, can decrease. For example, if interest rates rise, newly issued bonds will typically offer higher yields, making older bonds with lower interest rates less attractive and therefore leading to a decline in their market value. This risk is particularly significant for investors holding long-term securities, as they are more sensitive to interest rate changes compared to short-term investments.

In the context of investment management, understanding and managing interest rate risk is crucial for portfolio performance, as it can directly impact the return on investments and overall financial stability. This concept highlights why monitoring interest rate trends and making informed investment decisions is essential for preserving capital and optimizing returns in a fluctuating financial environment.