What is the effect of central bank monetary policy on interest rate risk?

Central bank monetary policy plays a crucial role in influencing interest rates and the overall yield curve. When central banks adjust their monetary policy—such as changing the policy interest rate, engaging in open market operations, or using quantitative easing techniques—they can directly affect both short-term and long-term interest rates.

For example, an increase in the policy interest rate typically leads to higher short-term interest rates and can also influence expectations about future inflation and economic activity, which can raise long-term rates as well. The yield curve, which depicts the relationship between interest rates and the maturity of debt, can shift in response to these monetary policy changes. This can have significant implications for borrowers and investors, as the shape of the yield curve affects loan rates, investment decisions, and overall economic activity.

Thus, the correct understanding is that central bank actions do indeed have a substantial impact on interest rates and the yield curve, making the choice that highlights this relationship accurate. Other choices overlook these effects or narrow the focus incorrectly, such as stating that they only affect short-term rates or suggesting a complete mitigation of interest rate risk.