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Interest rate risk is the risk that arises for bond owners from fluctuating interest rates. How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes in the market. The sensitivity depends on two things, the bond's time to maturity, and the coupon rate of the bond. [1]
A basic interest rate pricing model for an asset is = + + + where i n is the nominal interest rate on a given investment i r is the risk-free return to capital i* n is the nominal interest rate on a short-term risk-free liquid bond (such as U.S. treasury bills).
Maturity risk, or duration risk, is closely related to interest rate risk. Bonds with a longer term carry more risk because there is a longer period during which interest rates may rise.
Interest rate risk can affect the financial position of a bank and may create unfavorable financial results. [8] The potential for the interest rate to change at any given time can have either positive or negative effects for the bank and the consumer. If a bank gives out a 30-year mortgage at a rate of 4% and the interest rate rises to 6%, the ...
This risk, also called market risk, can also cause bond prices to rise if interest rates fall. A fixed-income investment’s loss of value due to interest rate risk can exceed the anticipated ...
1998 FED Trading and Capital Markets Activities Manual (section 3010 Interest-Rate Risk Management, pages 327 to 353) Has excellent coverage of Interest-Rate Risk Management, Camels Ratings and audit examination procedures. 1998 OCC Comptroller's Handbook on Interest Rate Risk; 1998 OCC OCC Risk Management of Financial Derivatives
For individual bonds and other fixed income securities, specific credit and interest rate risks can be hedged [98] using interest rate-and credit derivatives. Sensitivities re interest rates are measured using duration and convexity for bonds, and DV01 and key rate durations generally, and an offsetting derivative-position is purchased.
Nevertheless, the most commonly used types of market risk are: Equity risk, the risk that stock or stock indices (e.g. Euro Stoxx 50, etc.) prices or their implied volatility will change. Interest rate risk, the risk that interest rates (e.g. Libor, Euribor, etc.) or their implied volatility will change.