Interest rate risk is the potential for the value of a fixed-income investment — bonds, debentures, debt mutual funds, or fixed deposits — to decline as a result of rising market interest rates, or conversely, to increase when rates fall. The inverse relationship between interest rates and bond prices is fundamental to fixed income markets: when the RBI raises its repo rate or market yields rise, existing bonds with lower coupon rates become less attractive relative to new higher-yielding bonds, causing their market prices to fall. The magnitude of price sensitivity to interest rate changes is measured by duration — a bond with a 7-year duration loses approximately 7% in market value for each 1% rise in yields. In Indian debt mutual funds, interest rate risk is the dominant risk for long-duration fund categories — gilt funds, long-duration funds, and 10-year constant maturity funds experienced significant NAV erosion during the RBI's rate hiking cycles. For Indian investors, interest rate risk management involves matching investment duration to the investment horizon, laddering bond maturities, and monitoring the RBI's monetary policy stance to anticipate yield direction. SEBI's risk-o-meter framework for debt mutual funds explicitly incorporates duration-based interest rate risk in overall scheme risk classification.
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