Which type of risk is characterized by the inverse relationship between bond prices and interest rates?

The relationship between bond prices and interest rates is fundamental to understanding fixed-income investments. When interest rates rise, the prices of existing bonds typically decline. This is because new bonds are issued at higher interest rates, making older bonds with lower rates less attractive. Conversely, when interest rates fall, existing bonds become more valuable as they offer higher coupon payments than newly issued bonds at the lower current rates.

This dynamic is known as interest rate risk, which refers specifically to the potential for investment losses that can result from a change in interest rates. Investors holding bonds are subject to this risk because changes in prevailing interest rates can lead to significant fluctuations in bond market prices. Understanding this relationship is crucial for bond investors and those managing fixed income portfolios, as it directly impacts portfolio valuation and investment decisions.

Other risks mentioned, such as market risk, purchasing power risk, and specific risk, address different aspects of investment risk and do not specifically pertain to the relationship between bond prices and interest rates. Market risk refers to the risk of losses due to overall market movements, purchasing power risk relates to inflation's impact on returns, and specific risk pertains to risks associated with a particular investment or issuer. None of these encapsulate the nuanced dynamics of how interest rates affect bond pricing.