What does interest rate risk involve?

Interest rate risk specifically refers to the potential for investment values to decline as a result of changes in interest rates. When interest rates rise, the value of existing fixed-income investments, such as bonds, tends to fall because new bonds are issued at higher rates, making the older, lower-yielding bonds less attractive. This inverse relationship is crucial for investors to understand, particularly those involved in bonds or other interest-rate-sensitive securities.

In contrast, other types of risks mentioned, such as the risk of losing principal due to a stock market crash or risks associated with corporate earnings reports, pertain more to market volatility or business performance rather than interest rate fluctuations. Legislative changes can impact interest rates indirectly, but they do not define interest rate risk in the way that fluctuations in rates directly affect securities' market value. Thus, the correct understanding of interest rate risk is focused on the relationship between interest rates and the value of investments.