Glossary
Interest-rate risk
The risk that rising interest rates lower the price of existing bonds and other rate-sensitive investments.
Interest-rate risk is the chance that a change in market interest rates reduces the value of an investment. It bites hardest on bonds: a bond's coupon is fixed, so when new bonds start paying more, the old one is only worth buying at a lower price. The same force weighs on preferred stocks, dividend payers valued like bonds, and growth stocks whose profits lie far in the future.
How much a bond moves
The key measure is duration, which estimates the percentage price change for a one-point move in yields. Longer maturities and lower coupons mean higher duration and more sensitivity.
Real markets have shown how large this can get. In 2022, as the Federal Reserve raised rates quickly, the broad US investment-grade bond market lost roughly 13%, its worst calendar year in decades, with almost no default losses involved.
The other side of the risk
Falling rates raise bond prices but create reinvestment risk: coupons and maturing principal have to be reinvested at lower yields. Investors manage the trade-off by matching duration to when they need the money, laddering maturities, or holding floating-rate notes and short-term bills whose prices barely move. Holding a bond to maturity removes the price risk only if you never need to sell early.