Interest Rate Risk

Interest rate risk is the risk that bond prices will decline when interest rates increase. When the coupon rate on a bond is equal to the market rate, the bond will sell at par. When the coupon rate on a bond is greater than the market rate (because the market rate has declined), the bond will sell at a premium. When the coupon rate is less than the market rate (because the market rate has increased), the bond will sell at a discount. The market rate adjusts the price of the bond to produce a market yield based on the coupon amount. Interest rate risk is a function of the bond's maturity (longer-term bonds are more volatile than short?term bonds), the bond's coupon rate (if a bond's coupon rate is lower, it will experience greater volatility), and the bond's yield (the higher the yield, the lower the volatility). Interest rate risk is measured by a calculated factor called duration. See also credit risk and default risk and reinvestment risk