What is a potential risk when trading based on yield curve movements?

Duration risk is a critical consideration when trading based on yield curve movements. It refers to the sensitivity of the price of a bond or bond portfolio to changes in interest rates, which are fundamentally influenced by movements in the yield curve. When the yield curve shifts, it can lead to fluctuations in interest rates, impacting the value of fixed-income securities.

If an investor holds a bond with a longer duration, any increase in interest rates will result in a more significant decrease in the bond’s price compared to a bond with a shorter duration. Therefore, when traders attempt to profit from expectations about yield curve shifts, they must be cognizant of how these movements will impact their positions, particularly regarding duration exposure.

This understanding helps in managing risk effectively, ensuring that traders are not overly exposed to adverse price changes due to interest rate adjustments. Failing to account for duration risk can lead to unexpected losses or diminished returns when the yield curve behaves differently than anticipated.