Question

explain interest rate risk or maturity price risk faced by short term and long term investors in bonds using an example

Answer 1

Interest rate risk is defined as the risk of change in the value of an asset as a result of volatility in interest rates. This is the general definition of interest rate risk.

example for short term investors interest rate risk --

say an investor buys a 2-year, ₹3000 bond with a 2% coupon. Then, interest rates rise to 5%. The investor will have trouble selling the bond when newer bond offerings with more attractive rates enter the market. The lower demand also triggers lower prices on the secondary market. The market value of the bond may drop below its original purchase price.

Example for long term investors interest rate risk --

If an investor has invested some amount in a fixed rate for 20 -year . the bond at the prevailing price, which offers him a coupon rate of 3% and if there after interest rises to 7%, then the price of the bond would decline. This is because the bond is offering a rate of 3% while the market is offering a rate of return of 7%, hence if the investor wants to sell this bond in the market, the buyer would offer him the lesser amount for the bond as this bond is low-yielding as compared to the market.

So in this case investor again in the risk of interest rate risk.

This is the example for both cases. You can make many examples like that in which investors in interest rate risk in both short term and long term plan.

If you are satisfied plz do thumb's up....