Which type of risk arises when interest rates increase and affects the price of outstanding bonds?

Interest rate risk refers to the potential for investment losses that could occur due to changes in interest rates. When interest rates rise, the price of outstanding bonds typically falls. This happens because new bonds are likely to be issued with higher yields, making existing bonds with lower yields less attractive. Investors will therefore demand a discount on these existing bonds to compensate for the lower yield, leading to a decrease in their market price.

Understanding interest rate risk is crucial for both individual and institutional investors alike. When assessing investments, particularly fixed-income securities like bonds, it's important to consider how fluctuations in interest rates can impact their value. This risk is particularly significant for long-duration bonds, which tend to have greater price volatility in relation to interest rate changes.

In contrast, the other types of risks listed do not specifically pertain to how interest rate fluctuations influence bond prices:

• Credit risk pertains to the likelihood that a bond issuer will default on their payments.
• Liquidity risk involves the difficulty of selling an asset without incurring a significant loss or the inability to sell it at all.
• Market risk refers to the risk of losses in investments due to factors that affect the overall market, rather than specific securities or interest rate changes.

Therefore, the classification of interest rate risk accurately