Term risk

Definition

Term risk refers to the potential for bond prices to fluctuate due to changes in interest rates over time. Longer-term bonds are generally more sensitive to interest rate changes, increasing the term risk.

5 Must Know Facts For Your Next Test

1. Term risk is higher for long-term bonds than short-term bonds.
2. It is also known as interest rate risk.
3. When interest rates rise, the price of existing bonds typically falls.
4. Term risk impacts the yield curve, with longer maturities generally offering higher yields to compensate for increased risk.
5. Diversification can help manage term risk by balancing investments in various maturities.

Review Questions

• Why do longer-term bonds have higher term risk?
• How does a change in interest rates affect the price of existing bonds?
• What strategies can be used to manage term risk?

Related terms

Yield Curve: A graph that shows the relationship between bond yields and maturities.

Interest Rate Risk: The possibility of a reduction in the value of a fixed-income investment due to a rise in interest rates.

Duration: A measure of a bond's sensitivity to changes in interest rates, expressed in years.