What is the relationship between longer term bonds and interest rate risk?

The correct answer highlights the inherent characteristics of longer-term bonds in relation to interest rate risk. Longer-term bonds are indeed at greater interest rate risk because they have a longer time until maturity, which means that their cash flows (interest payments and principal repayment) are exposed to fluctuations in interest rates for an extended period.

When interest rates rise, the prices of existing bonds typically fall. This is because new bonds are issued at higher rates, making existing bonds with lower rates less attractive. The longer the time until a bond matures, the greater the potential for interest rate changes to impact its price. For instance, if a bond has a maturity of 20 years, a change in interest rates can significantly affect its market value over that period.

Conversely, shorter-term bonds are less sensitive to interest rate changes because they mature sooner, allowing investors to reinvest their capital at current rates more quickly. This characteristic makes longer-term bonds, with their extended exposure period to rate fluctuations, inherently riskier in terms of interest rate movements.

Understanding this relationship is crucial for investors as they consider their investment strategies and risk tolerance. Those investing in longer-term bonds should be aware of the potential for price volatility due to interest rate changes, which is a fundamental aspect of bond