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Shape Risk

Shape risk refers to the risk that arises from changes in the shape of the yield curve, which depicts the relationship between interest rates and different maturity dates of bonds. As interest rates fluctuate, the yield curve can steepen, flatten, or invert, affecting bond prices and the returns on interest rate-sensitive investments. Shape risk is a particular concern for bond traders and portfolio managers who need to manage the impact of interest rate changes on their holdings.

Example

A portfolio of long-term bonds may be exposed to shape risk if the yield curve steepens, causing long-term bond prices to drop significantly compared to short-term bonds.

Key points

• Risk associated with changes in the yield curve.

• Affects bond prices and interest rate-sensitive investments.

• Important for managing bond portfolios.

Quick Answers to Curious Questions

Changes in the yield curve can lead to fluctuations in bond prices, particularly for long-term bonds.

Managing shape risk helps portfolio managers protect against significant losses due to changes in the interest rate environment.

Short-term bonds are less sensitive to yield curve changes, while long-term bonds are more exposed to shifts in interest rates, affecting their prices more dramatically.