By Harry Prabandham · Updated September 28, 2026
Investing & Markets
Interest Rate Risk: Duration, the Yield Curve, and Rate Sensitivity
Interest rate risk is the chance that rate changes lower an investment's value. For bonds, prices fall when rates rise, and duration measures how much.
Interest Rate Risk: Duration, the Yield Curve, and Rate Sensitivity
1 / 7
What is interest rate risk?
- Interest rate risk is the risk that a change in market interest rates reduces the value of an investment.
- Fixed-rate bond prices move opposite to rates: when rates rise, existing bonds with lower coupons are worth less.
- Falling rates create a different problem, reinvestment risk, because maturing money earns less.
- Rate changes also affect stocks, real estate, and anything valued on future cash flows.
Try Our Free Tools
Full Guide
What is interest rate risk?
- Interest rate risk is the risk that a change in market interest rates reduces the value of an investment.
- Fixed-rate bond prices move opposite to rates: when rates rise, existing bonds with lower coupons are worth less.
- Falling rates create a different problem, reinvestment risk, because maturing money earns less.
- Rate changes also affect stocks, real estate, and anything valued on future cash flows.
What is duration and how is it used?
- Duration estimates how much a bond's price changes for a one-percentage-point change in rates.
- As a rough guide, a bond with a duration of five years would lose about 5% in price if rates rose by one percentage point.
- Longer maturities and lower coupons mean higher duration and more sensitivity.
- Effective duration adjusts for call features and mortgage prepayments, which can change a bond's behavior as rates move.
Which investments are most rate-sensitive?
- Long-term Treasuries and zero-coupon bonds are among the most sensitive to rate changes.
- Short-term Treasuries and money market funds have little price sensitivity but reset to lower yields when rates fall.
- Corporate bonds carry rate risk plus credit spread risk, which can move in either direction.
- Stocks whose value rests on distant future earnings, and real estate financed with debt, can also be pressured by rising rates.
What does the yield curve show?
- The yield curve plots Treasury yields across maturities, and it normally slopes upward.
- An inverted curve, with short rates above long rates, has preceded most U.S. recessions since the 1960s, though timing varies and it is not a sure signal.
- The gap between 10-year and 3-month or 2-year Treasury yields is a widely watched measure.
- Curve shape reflects expectations for growth, inflation, and Fed policy.
How does Federal Reserve policy affect rates?
- The Federal Open Market Committee sets a target range for the federal funds rate, which anchors other short-term rates.
- Longer-term yields reflect market expectations for inflation, growth, and future policy, so they can move differently from the Fed's rate.
- The Fed's balance sheet decisions, buying or shrinking holdings of Treasuries and mortgage securities, also influence long-term yields.
- Markets often move before an actual Fed decision based on what they expect.
How do investors manage interest rate risk?
- Matching bond maturities to when the money will be needed reduces the chance of selling at a loss.
- A bond ladder spreads maturities over time so some money comes due regularly for reinvestment.
- Shorter duration lowers price sensitivity but increases reinvestment risk; longer duration does the reverse.
- Rate forecasts are unreliable, so many investors diversify across maturities rather than betting on a direction.
Key takeaways
- Bond prices move opposite to interest rates, and duration measures the size of that move.
- Long-duration and zero-coupon bonds are most sensitive; short-term holdings trade price risk for reinvestment risk.
- The Fed controls short-term rates, while markets set long-term yields.
- Aligning maturities with cash needs is one of the more reliable ways to manage rate risk.
Related Topics
Investing & Markets
Bond Basics: How Bonds, Yields and Duration Work
A bond is a loan that pays interest and returns principal at maturity. Bond prices fall when rates rise, and longer bonds move more.
Investing & MarketsBond Ladders: How They Work, Benefits and Trade-offs
A bond ladder holds bonds or CDs maturing on staggered dates, spreading reinvestment across rate environments and scheduling predictable cash flows.
Investing & MarketsTreasuries, I Bonds, and TIPS: How U.S. Government Securities Compare
T-bills, notes, and bonds pay fixed rates; I bonds and TIPS adjust for inflation. All are state-tax-exempt, but limits, liquidity, and taxes differ.