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Difficulty: EasyDebt Securities and Bond Structure

An investor holding a 10-year U.S. Treasury bond is concerned that rising interest rates in the secondary market will cause the bond's market value to decline prior to its maturity date. Which type of risk does this scenario best represent?

  1. Interest rate riskAnswer
  2. B
    Credit risk
  3. C
    Call risk
  4. D
    Liquidity risk

Answer

Interest rate risk is the risk that an increase in prevailing market interest rates will cause the market price of existing fixed-income debt securities to decline.
Interest rate risk directly describes the vulnerability of a bond's market price to changes in prevailing interest rates. When interest rates rise, existing bonds with lower coupon rates become less attractive, causing their secondary market prices to drop.

Step-by-Step Solution

1
Identify the core cause and effect described in the stem.
Rising interest rates leading to a decrease in the bond's secondary market value.
Bond prices and market interest rates share an inverse relationship.
2
Match the risk characteristic to standard fixed-income risk definitions.
The risk of fixed-income price decline due to interest rate fluctuations is defined as interest rate risk.
U.S. Government debt securities carry negligible default/credit risk, making interest rate risk their primary market risk.

Key Concept

Inverse Relationship Between Bond Prices and Interest Rates
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Topics

Debt Securities and Bond Structure

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