# Interest Rate Sensitivity: Definition, What It Measures, and Types

## What Is Interest Rate Sensitivity?

Interest rate sensitivity is a measure of how much the price of a fixed-income [asset](https://www.investopedia.com/terms/a/asset.asp) will fluctuate as a result of changes in the interest rate environment. Securities that are more sensitive have greater price fluctuations than those with less sensitivity.

This type of sensitivity must be taken into account when selecting a bond or other fixed-income instrument the investor may sell in the [secondary market](https://www.investopedia.com/terms/s/secondarymarket.asp). Interest rate sensitivity affects buying as well as selling.

### Key Takeaways

*   Interest rate sensitivity is how much a fixed-income asset price moves with changes in interest rates.
*   Interest rates and fixed-income asset prices are inversely correlated.
*   More interest rate sensitivity means an asset's price fluctuates more with a change in interest rates.
*   The longer the maturity of the asset, the more sensitive the asset to changes in interest rates.

## How Interest Rate Sensitivity Works

Fixed-income securities and interest rates are inversely correlated. Therefore, as interest rates rise, prices of fixed-income securities tend to fall. When applied to calculate fixed income securities, interest rate sensitivity is known as the asset's [duration](https://www.investopedia.com/terms/d/duration.asp). This is one way to determine how interest rates affect a fixed-income security portfolio. The higher a bond or bond fund's duration, the more sensitive the bond or bond fund to changes in interest rates.

The duration of fixed-income securities gives investors an idea of the sensitivity to potential interest rate changes. Duration is a good measure of interest rate sensitivity because the calculation includes multiple bond characteristics, such as coupon payments and maturity.

Generally, the longer the maturity of the asset, the more sensitive the asset to changes in interest rates. Changes in interest rates are watched closely by bond and [fixed-income](https://www.investopedia.com/terms/f/fixedincome.asp) traders, as the resulting price fluctuations affect the overall yield of the securities. Investors who understand the concept of duration can immunize their fixed-income [portfolios](https://www.investopedia.com/terms/p/portfolio.asp) to changes in short-term interest rates.

## Types of Interest Rate Sensitivity

There are four widely used duration measurements to determine a fixed-income security's interest-rate sensitivity—the [Macaulay duration](https://www.investopedia.com/terms/m/macaulayduration.asp), modified duration, effective duration, and key rate duration. To [calculate the Macaulay duration](https://www.investopedia.com/ask/answers/051515/how-do-i-calculate-bonds-modified-duration-using-excel.asp) certain metrics must be known, including the time to maturity, remaining cash flows, required yield, cash flow payment, par value, and bond price.

The [modified duration](https://www.investopedia.com/terms/m/modifiedduration.asp) is a modified calculation of the Macaulay duration that incorporates [yield to maturity (YTM)](https://www.investopedia.com/terms/y/yieldtomaturity.asp). It determines how much the duration would change for each percentage point change in the yield.

The [effective duration](https://www.investopedia.com/terms/e/effectiveduration.asp) is used to calculate the duration of bonds with embedded options. It determines the approximate price decline for a bond if interest rates rise instantaneously by 1%. The [key rate duration](https://www.investopedia.com/terms/k/keyrateduration.asp) determines a fixed-income security's or fixed-income portfolio's duration at a specific maturity on the yield curve.

## Example of Interest Rate Sensitivity

One widely used measure to determine the interest rate sensitivity is the effective duration. For example, assume a bond mutual fund holds 100 bonds with an average duration of nine years and an average effective duration of 11 years. If interest rates rise instantaneously by 1.0%, the bond fund is thus expected to lose 11% of its value based on its effective duration.

Likewise, a trader can look at a particular corporate bond with a maturity of six months and a duration of 2.5. If interest rates fall 0.5%, the trader can expect that the bond's price to rise by 1.25%.

> **Article Sources**
>
> 1.  Morningstar. "[What Is Duration?](https://www.morningstar.com/investing-definitions/duration)"
>     
> 2.  CFA Institute. "[Understanding Fixed-Income Risk and Return](https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/understanding-fixed-income-risk-return)."
>     
> 3.  BlackRock. "[What is Bond Duration?](https://www.blackrock.com/us/individual/education/understanding-duration)"