What is the risk called when rising interest rates cause a decline in the market value of a mortgage-backed security?

The correct answer is interest rate risk, which refers specifically to the potential for investment losses that occur due to rising interest rates. When interest rates increase, the market value of existing fixed-income securities, such as mortgage-backed securities, typically declines. This happens because new securities are issued at higher rates, making older ones less attractive. Investors tend to require a higher return for taking on the risk associated with locking in lower rates on older securities, leading to a drop in their market prices.

Understanding this risk is crucial for investors considering mortgage-backed securities, as their performance is significantly influenced by fluctuations in interest rates. Unlike other types of risks, interest rate risk directly correlates with the changes in prevailing interest rates and can lead to substantial impacts on the valuation of fixed-income investments.