Interest Rate Sensitivity
Candlefocus EditorFixed-income assets such as bonds and debentures are subject to inverse correlation with changes in interest rates. As interest rates rise, the price of the asset will decrease and vice versa, the lower the interest rate, the higher the asset price. The magnitude of the changes in asset price will depend on the approximate length of the maturity date of the asset which is known as the interest rate sensitivity.
The longer the maturity, the higher the sensitivity of price changes to interest rate movements. For example, if the interest rate increases or decreases by 1.5%, a long-term bond or debenture would experience a much greater percentage change of price than a short-term asset with the same maturity rate. This relationship is known as the ‘inverse relationship of bonds and interest rates’.
When making an investment decision, it is important to take into account the sensitivity of a fixed-income asset to changes in interest rates. If interest rates are likely to rise or fall, then investors have to decide whether the potential change in price is worth the risk. By understanding the relationship between interest rates and bond prices, investors can assess the level of risk of their investments and decide if they want to invest in a particular bond.
Interest rate sensitivity is an important factor to consider when investing in and determining the value of fixed-income securities. Investors should always be aware of the importance of understanding and anticipating the impact of interest rate changes on the performance of their investments. By understanding the sensitivity of a bond or debenture to changes in interest rates, investors are better able to make an informed decision before investing in a particular asset.