What is meant by interest rate risk?

Interest rate risk refers to the potential for investment losses that arise from fluctuations in interest rates. When interest rates change, the value of fixed-income investments like bonds can be affected significantly. For example, if interest rates rise, the existing bonds that pay lower interest rates become less attractive to investors, leading to a decrease in their market value. Conversely, when interest rates fall, existing bonds with higher rates become more desirable, increasing their market value.

This risk is particularly relevant for long-term investments, as they are more sensitive to interest rate changes compared to short-term investments. For investors holding fixed-rate investments, particularly bonds, understanding interest rate risk is crucial for managing their portfolios and making informed investment decisions.

The other options address different aspects of financial risks but do not accurately define interest rate risk. For instance, the risk of not earning any interest on investments does not encompass the effects of changing interest rates on the value of existing investments. Similarly, while borrowing at a variable interest rate does involve some risk, it specifically relates to fluctuations in borrowing costs rather than the broader impact on investment values. Lastly, inflation affecting interest rates is an important concept in finance, but it relates more to the relationship between inflation and interest rates, rather than the direct risk to investments