Interest Rate Risk

Abstract

When investing in bonds, it may seem that there is no risk, especially when purchasing a bond where the amount of money paid by each coupon and the bond face value are known. However, although the amount of the coupons and the repayment are known, the investor’s final return can change for various reasons, mainly due to interest rate variation. With the exception of default risk, the price of the bond in question is simply $P=\frac{C}{{\left(1+r\right)}^{T_1}}+\ldots +\frac{C+N}{{\left(1+r\right)}^{T_J}}$ where C is the coupon, N is the face value, r is the interest rate (which in this case, for simplicity, is assumed to be the same in each maturity time) and T ₁, T ₂, …, T _J are the moments in time when the coupon and interest payment occur. Thus, if the interest rate changes, the price of the bond in question also varies, and the longer the payment period is, the greater the variation becomes.