A:

Bond investors, specifically those who invest in long-term fixed-rate bonds, are more directly susceptible to interest rate risk. This is because of the close relationship between interest rates and bond prices. When interest rates rise, bond prices fall and vice versa. In a rising interest rate environment, for example, this creates risk. The following is an illustration of how this works:

Suppose an individual purchases a 3% fixed-rate 30-year bond for $10,000. This bond pays $300 per year through maturity. If, during this time, interest rates rise to 3.5%, new bonds issued pay $350 per year through maturity, assuming a $10,000 investment. If the 3% bondholder continues to hold his bond through maturity, he loses out on the opportunity to earn a higher interest rate. Alternatively, he could sell his 3% bond in the market and buy the bond with the higher interest rate. However, doing so results in the investor getting a lower price on his sale of 3% bonds as they are no longer as attractive to investors since the newly issued 3.5% bonds are also available.

In contrast, changes in interest rates also affect equity investors but less directly than bond investors. This is because, for example, when interest rates rise, the corporation's cost of borrowing money also increases. This could result in the corporation postponing borrowing, which may result in less spending. This decrease in spending may slow down corporate growth and result in decreased profit and ultimately lower stock prices for investors.

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