What does interest rate risk refer to?

Interest rate risk refers to the potential for changes in interest rates to have a negative impact on the value of an investment. This risk is particularly relevant for fixed-income securities, such as bonds, whose prices are inversely related to interest rate movements. When interest rates rise, the existing fixed-rate bonds in the market become less attractive compared to new bonds being issued at higher rates. Consequently, the market price of existing bonds falls, resulting in potential losses for investors holding these securities. Understanding interest rate risk is critical for investors as it can significantly influence the returns of their investment portfolios, especially in environments of fluctuating interest rates.

The other options address concepts that, while related to interest rates, do not accurately define interest rate risk in the context of investment valuation. For example, the likelihood of default on a loan pertains to credit risk, while the volatility of interest rates describes the variability of rates over time rather than their direct impact on investment values. Additionally, the potential for interest rates to rise above current levels speaks more to market expectations than to the risk associated with fluctuating rates influencing asset valuation. Thus, option B captures the essence of interest rate risk in relation to investments.