Interest Rate Risk

Think about rising rates when you hear the term interest rate risk. For example, if you have a variable rate mortgage or own a bond, you’re exposed to interest rate risk. The higher the risk, the more susceptible your investments are to the rise in the cost of borrowing. In the case of a floating-rate mortgage, the exposure is straightforward. If interest rates are higher when your mortgage is to reset, you just have to fork-out more each month. In the case of bonds, rising interest rates lead to falling bond prices, and a shrinking of your portfolio. It may seem counter to common sense but this is how the relationship between interest rates and bond prices plays-out. When interest rates rise, the old bonds are less attractive than new instruments that pay-out more. As a result, there is less demand and lower prices for the lower yielding bonds.