What is "interest rate risk" in bond investing?

Interest rate risk in bond investing refers to the potential for bond prices to decline when interest rates rise. This occurs because of the inverse relationship between bond prices and interest rates. When prevailing interest rates increase, newly issued bonds generally offer higher yields to attract investors. Consequently, existing bonds with lower yields become less attractive, leading to a decrease in their market prices. This phenomenon can significantly affect the value of bonds held in an investment portfolio.

Understanding this risk is crucial for investors, as it can impact the return on investment if bonds are sold before maturity. It’s important to note that while other types of risks, such as inflation risk, default risk, and currency risk, are also relevant in bond investing, they pertain to different aspects of risk management rather than specifically addressing fluctuations in interest rates and their impact on bond pricing.