Learn what interest-rate risk means, why it matters for bonds and financial institutions, and how duration helps measure it.
Interest-rate risk is the risk that changes in market interest rates will reduce the value of assets, change funding costs, or alter future income.
It is one of the central risks in fixed income and banking because rate changes affect both present values and future cash-flow conditions.
Interest-rate risk matters for:
If rates rise, the value of many existing fixed-rate bonds falls. If rates fall, reinvestment income may decline. Institutions with mismatched assets and liabilities can also be exposed.
The risk that rising yields reduce the market value of existing fixed-rate assets.
The risk that future cash flows must be reinvested at lower yields.
The risk that assets and liabilities reprice differently, which can squeeze net interest margins or balance-sheet value.
Duration is one of the most useful tools for measuring interest-rate risk because it estimates how strongly a bond’s price may respond to a yield change.
Modified Duration takes that one step further by converting the measure into a direct price-sensitivity approximation.
Suppose a bank funds itself with short-term deposits but holds long-term fixed-rate loans. If short-term rates rise sharply, deposit costs can rise faster than the income from those long-term loans.
That is a classic form of interest-rate risk.
This distinction matters:
Both can hit a bond’s price, but they are different risk drivers.