Interest Rate Risk

From Open Risk Manual

Definition

Interest rate risk is the risk that fluctuating interest rates will adversely affect the Contractual Cash Flows and/or value of an interest rate sensitive financial asset or liability such as a loan, bond or derivative position

Interest rate risk is similar to other types of Market Risk. For banks, the treatment of interest risk has several peculiarities due to the accounting approach used

Causes

The degree of interest rate risk embedded in a financial product is linked to the sensitivity of its individual cashflows to interest rate changes in markets

That sensitivity in turn depends on

  • the (relative) size of the different cashflows
  • the timing of the cashflows and
  • their contractual dependence on market rates

Issues and Challenges

  • A large fraction of a bank's assets are not marked-to-market

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