What does interest rate risk refer to?

Interest rate risk specifically refers to the potential for investors to experience losses in the value of their securities due to changes in interest rates. When interest rates rise, the prices of existing bonds tend to fall, as new bonds are issued with higher yields. This inverse relationship is a core characteristic of fixed-income investments. Therefore, if an investor holds bonds with lower interest rates, their market value will decrease compared to newly issued bonds that offer higher yields.

This concept is critical for understanding how changes in monetary policy and economic conditions can influence investment portfolios. As rates rise, investors may seek out the higher returns offered by newly issued securities, leading to a decline in demand for existing bonds, which compounds the risk of loss for those holding older securities.

In contrast, the other options focus on different types of risks that do not directly pertain to the impact of interest rate fluctuations on the value of securities. For example, the first option addresses market demand instead of interest fluctuations, while inflation risk pertains to purchasing power rather than investment value directly. Market volatility, lastly, relates broadly to price fluctuations in securities without a specific emphasis on interest rates.