What does the term "interest rate risk" represent in financial management?

The term "interest rate risk" primarily refers to the potential for investment losses resulting from fluctuations in interest rates. This risk is particularly relevant for fixed-income securities, such as bonds, where the market value of these instruments can fluctuate as interest rates change. When interest rates rise, the price of existing fixed-rate bonds typically falls, which can lead to capital losses for investors holding those bonds. Conversely, when interest rates decline, the value of existing bonds tends to increase.

Understanding interest rate risk is crucial for financial managers, as it impacts their decision-making regarding investment strategies, asset-liability management, and the overall risk profile of their portfolios. This risk can also affect interest-dependent sectors within the economy, influencing borrowing costs and, ultimately, economic growth. By recognizing and mitigating interest rate risk, financial professionals can better safeguard investments and optimize returns for their clients or organizations.