# Interest Rate Risk

Holding all else constant, Interest Rate Risk is higher if: -the coupon is smaller -the maturity is longer -the market yield is lower Can someone explain the intuition behind these? Thanks in advance.

Coupon Smaller - Zero coupon bonds are more reactive to interest rates while high yielding bonds less reactive. Therefore a small or no coupon bond has higher interest rate risk. Think of it like that. Maturity is longer - More risk exists since bonds are not as liquid as equities. One will usually hold the bond to maturity. A longer maturity means a longer uncertainty of interest rates. Market yield is lower - I need to review this one in more detail, but I think its because when a market yield is low, it is likely that it may rise. And bonds act inversely to interest rate movements. So the bond price will fall as interest rates rise. Good Luck.

It may help to think of interest rate risk as the %price change for a given %change in yield. This is known as duration. duration = (%changeprice)/(%changeyield) For the lower market yield, CFAI explains it on pg 268. If you go through the calculations, %change price is greater when market yields are lower.

vbcfa Wrote: ------------------------------------------------------- > Holding all else constant, Interest Rate Risk is > higher if: > -the coupon is smaller you can think of interest rate risk in terms of duration. duration is weighted average time of cash flows. if coupons are large - weighted average time is smaller (duration smaller), coupons are small -> weighted average time is larger (duration larger) > -the maturity is longer maturity is longer -> duration is larger > -the market yield is lower you have to look at the chart. easy to see for zero-coupon bond F/(1+r)^T -> duration = F*T/(1+r)^{T+1} -> larger for smaller interest rate

you guys are awesome - this makes a lot more sense now. thanks so much.