What does interest rate risk refer to?

Interest rate risk specifically refers to the potential for investment losses that can occur as a result of fluctuations in interest rates. This type of risk is particularly relevant for fixed-income investments, such as bonds. When interest rates rise, the prices of existing bonds generally fall because new bonds are issued at higher rates, making the older bonds less attractive. Conversely, when interest rates fall, the prices of existing bonds tend to rise. Investors who hold bonds that are sensitive to these changes in interest rates are exposed to the possibility of losing money if they need to sell their bonds at a time when interest rates have risen.

The other options do not encapsulate the definition of interest rate risk. For instance, concerns about a borrower's ability to repay loans relate more to credit risk rather than interest rate risk. The risk of inflation deteriorating the real value of returns speaks to purchasing power risk, while the effect of economic cycles on the stock market pertains to market risk. Understanding interest rate risk is vital for investors to appropriately manage their portfolios and make informed decisions based on projected interest rate movements.