Which type of bonds is more sensitive to interest rate changes?

Longer duration bonds are more sensitive to interest rate changes primarily because of the duration concept itself, which measures the sensitivity of a bond's price to changes in interest rates. Duration takes into account the time until the bond's cash flows will be received.

Long-term bonds typically have longer maturities, meaning their cash flows (both interest payments and principal repayment) are distributed further into the future. When interest rates rise, the present value of those future cash flows decreases significantly, leading to a larger drop in the market price of the bond. Conversely, if interest rates fall, the price of longer duration bonds increases more substantially compared to shorter duration bonds.

In contrast, shorter duration bonds have cash flows that are received sooner, which means their prices are less affected by interest rate changes. That makes them a safer choice in a rising interest rate environment. Corporate and municipal bonds can also vary in terms of interest rate sensitivity, but generally speaking, the duration is the key factor that affects how changes in interest rates impact bond prices. Thus, longer duration bonds inherently have a higher risk of price volatility due to those shifts in interest rates.