Interest rate risk is the exposure of an investment's or company's value to changes in prevailing interest rates. This type of risk is important in finance, as fluctuations in interest rates can significantly affect the value of financial instruments and obligations like bonds, loans, or fixed-income securities. For instance, when interest rates rise, the existing bonds with lower interest rates become less attractive, causing their market value to drop. Alternatively, when rates decline, bonds with higher rates increase in value. For companies, changes in interest rates can affect their cost of borrowing or the valuation of interest-sensitive assets and liabilities.

In practical applications, financial managers monitor and mitigate interest rate risk using strategies such as interest rate swaps, floating to fixed-rate conversions, or hedging instruments. For instance, a company with a floating-rate loan might choose to enter into a financial derivative agreement to fix their interest payments. Similarly, an investor might evaluate the duration of a bond portfolio to understand and manage the interest rate risk they are exposed to.

Interest rate risk is a crucial aspect of financial risk management and plays a significant role in the stability and profitability of organizations and investments.