In the context of finance, what does an increase in market rates often lead to regarding existing bonds?

In the context of finance, what does an increase in market rates often lead to regarding existing bonds?

• A. Inflation risk
• B. Interest rate risk
• C. Reinvestment risk
• D. Market liquidity risk

Answer: (B)

An increase in market interest rates generally leads to interest rate risk for existing bonds. When market interest rates rise, the prices of existing bonds tend to fall. This inverse relationship occurs because newly issued bonds will likely pay higher interest rates, making older bonds with lower rates less attractive to investors. As a result, the market value of existing bonds decreases, which represents the interest rate risk that bondholders face in a fluctuating interest rate environment. Interest rate risk particularly affects the fixed-income investments like bonds, where the cash flow is predetermined. Investors holding these bonds may experience capital losses if they need to sell before maturity in a higher interest rate scenario. Understanding this dynamic is essential for bond investors, as they must manage their portfolios in response to changing market conditions to mitigate potential losses.

An increase in market interest rates generally leads to interest rate risk for existing bonds. When market interest rates rise, the prices of existing bonds tend to fall. This inverse relationship occurs because newly issued bonds will likely pay higher interest rates, making older bonds with lower rates less attractive to investors. As a result, the market value of existing bonds decreases, which represents the interest rate risk that bondholders face in a fluctuating interest rate environment.

Interest rate risk particularly affects the fixed-income investments like bonds, where the cash flow is predetermined. Investors holding these bonds may experience capital losses if they need to sell before maturity in a higher interest rate scenario. Understanding this dynamic is essential for bond investors, as they must manage their portfolios in response to changing market conditions to mitigate potential losses.