Yield sensitivity or interest rate sensitivity is a measure of how much a fixed income asset’s price changes due to the fluctuation in interest rates.
The concept of yield sensitivity is vital to investors because it is a measure of how much the price of an asset will fluctuate because of an interest rate change. The higher the yield sensitivity, the more likely it is that the asset's price will decline on the rise of the interest rates.
Yield sensitivity can be positive or negative depending on whether a change in interest rate impacts the price of a bond positively or negatively.
It is typically measured by calculating the percentage change in price that would occur if a bond's coupon rate were to increase one percentage point. So, for example, a bond with a $1,000 par value that has a coupon rate of 5% and is currently selling for $1,050 would have a yield sensitivity of 5%. This means that if interest rates were to rise by just 1%, the bond's value would drop by 5%—to $950.
Treating interest rate sensitivity as an investment characteristic can help investors make better decisions about their portfolios.
Because interest rates affect the values of bonds and other fixed-income investments, investors need to be aware of their own sensitivity to interest rate changes when deciding how much exposure these securities should have in their portfolios.
Investors who are more sensitive to increases in interest rates tend to prefer investments with lower interest rate sensitivity — because they will be less likely to lose money if the market moves against them. Investors who aren't very concerned with rising interest rates tend to favor investments with higher interest rate sensitivity — because they aren't overly concerned with the value of the investment being negatively affected by a change in prevailing interest rates.
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