Interest rate risk refers to the potential for financial losses resulting from changes in interest rates. It primarily affects fixed-income securities such as bonds and loans. When interest rates fluctuate, the value of these instruments tends to move in the opposite direction. For instance, rising interest rates can lead to a decline in bond prices, causing capital losses for bondholders. The level of interest rate risk depends on factors such as the duration of the instrument, the magnitude of interest rate changes, and the sensitivity of the security to interest rate movements. Investors and financial institutions employ risk management strategies, such as hedging and diversification, to mitigate the adverse effects of interest rate fluctuations and safeguard their investment portfolios.
