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To calculate interest rate risk, you need to consider two key factors: the duration of the investment and the sensitivity of the investment’s value to changes in interest rates.
Duration measures the investment’s sensitivity to interest rate changes. A longer duration indicates greater sensitivity to interest rate changes, while a shorter duration indicates less sensitivity. To calculate duration, you can use a formula that takes into account the time to maturity of the investment, the coupon rate, and the yield to maturity.
Once you have calculated the duration, you can use it to estimate the investment’s sensitivity to interest rate changes. For example, if the duration of an investment is 5 years and interest rates rise by 1%, the investment’s value is expected to decrease by approximately 5%.
Overall, understanding and calculating interest rate risk is important for investors to make informed decisions about their portfolio and manage their exposure to interest rate fluctuations.
The effects of interest rates are often not directly felt but play out over a long time as valuations of real-estate and other assets adjust.
At Horizon65, we created a mobile app that enabled you to check the effect of high interest rates on your savings and to simulate potential investments that can defend against it.