AP MacroeconomicsMoney, Banking & Finance
Interest Rate Risk
Interest rate risk is the risk that rising market interest rates reduce the value of a bond or fixed-rate asset, since bond prices move inversely to rates.
When market rates rise, existing bonds paying lower fixed coupons become less attractive, so their prices fall — and longer-maturity (higher-duration) bonds fall more. Banks face it because they fund long-term fixed-rate loans with short-term deposits whose cost rises with rates. It is separate from credit risk (default) and liquidity risk (can't sell/fund).
Formula / Example
Bond price ↓ when market interest rates ↑ (inverse relationship); larger effect for longer maturities