One way to look at interest rate risk is to consider what happens to the value of your investment if interest rates change. Interest rate risk is fundamental to fixed income investments including U.S. Treasury bills, notes and bonds.
By way of example, as of this writing the benchmark ten year Treasury note yields 2.25% to maturity. If you invest today at 2.25% with the intention of holding to maturity, your interest rate is guaranteed. Your risk is limited to the opportunity cost associated with the timing of your investment. Perhaps if you wait a short time to invest, you can purchase your Treasury note with a 3.00% yield to maturity. That would be good. But consider the flip-side. If you wait and the market yield on the Treasury note falls by .75%, then you can lock in only a 1.50% yield to maturity. Not good. These three scenarios represent interest rate risk in its most basic form.
Next let’s look at your return if you invest today and sell in six months. The Bloomberg Total Return Analysis shown below tells the story.