Rate Level Risk

What Is Rate Level Risk?

Rate level risk is the possibility that an interest-bearing asset will lose value assuming market interest rates increase over its coupon rate.

Understanding Rate Level Risk

Interest rate risk is one of four principal factors influencing bond prices and typically increases with duration, a measure of the sensitivity of the price of a fixed-income investment to a change in interest rates, stated in terms of years.

At the point when a government or business issues fixed-income securities, the price and coupon are set by the issuer to be competitive inside the current rate environment. Bonds will be offered at prices in view of term structure and relating rates across the current yield curve. As interest rates differ going ahead, prices of existing bonds will vacillate likewise. At the point when interest rates increase, bond prices fall, and when interest rates decline, bond prices rise.

At the point when interest rates fall, holders of bonds and other fixed-income securities will typically see the value of their holding increase, even however the coupon rate is fixed. They might have the option to sell their bond at a higher cost than they paid for it. In any case, when rates increase, the value of a bond, or portfolio of bonds that have been issued at correspondingly lower rates, will diminish. At the point when the market interest rate increase crosses the level of the fixed-income investment's coupon rate, the investor stands to lose value. This will be promptly apparent in the daily pricing of bond mutual funds. For instance, during a period when longer-term rates are rising, a bond portfolio that has a concentration in longer-term bonds will see its value drop.

Investors who own individual bonds can hold their bonds to maturity (except if the bond has a call feature and is called) and receive the full return that the bond initially offered, notwithstanding a default. This accepts that the investor is comfortable with earning not as much as what might be available in the current market. For managers of large bond portfolios, rising rate levels essentially affect the value of the portfolio and the ability of the manager to draw in and hold investors. Hence, professional bond managers typically trade more much of the time than individual bondholders to create competitive pricing and yields for the portfolio.

Features

• At the point when market interest rates increase and cross the level of the coupon rate, the value of a bond will diminish and the investor stands to lose value on their investment.
• Rate level risk is the risk of an interest-bearing asset losing value in the case that market interest rates rise over its coupon rate.
• Interest rate risk is one of the primary factors influencing bond prices and typically increases with duration.