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Rate Risk

Rate risk, also known as interest rate risk, refers to the potential for losses in an investment or financial asset due to changes in interest rates. It is particularly relevant for fixed-income securities like bonds, where rising interest rates can cause the value of existing bonds to fall, as newer bonds offer higher yields. Rate risk can affect both the market value of bonds and the cost of borrowing, making it an important consideration for investors, businesses, and financial institutions.

Example

A bondholder experiences rate risk when rising interest rates cause the market value of their bond to decrease, as newer bonds offer more attractive yields.

Key points

• The potential for losses due to changes in interest rates.

• Particularly affects fixed-income securities like bonds.

• Can impact both asset values and borrowing costs.

Quick Answers to Curious Questions

When interest rates rise, the value of existing bonds decreases, as investors prefer newer bonds with higher yields.

Investors can use strategies like laddering bond maturities or investing in floating-rate securities to reduce exposure to interest rate changes.

Rising interest rates increase borrowing costs for companies, potentially reducing profits or deterring investment in new projects.
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