Interest rate risk is the risk that the relative value of an interest-bearing asset, such as a loan or a bond, will worsen due to an interest rate increase. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa. Interest rate risk is commonly measured by the bond's duration, the oldest of the many techniques now used to manage interest rate risk. Asset liability management is a common name for the complete set of techniques used to manage risk within a general enterprise risk management framework. For alternative meanings, see bond (a disambiguation page). ... An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... In finance, a fixed rate bond is a bond with a fixed coupon (interest) rate, as opposed to a floating rate note. ... In economics and finance, duration is the weighted average maturity of a bonds cash flows or of any series of linked cash flows. ... In banking, Asset Liability Management is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. ... For non-business risks, see risk or the disambiguation page risk analysis. ...

Calculating interest rate risk

Interest rate risk analysis is almost always based on simulating movements in one or more yield curves using the Heath-Jarrow-Morton framework to ensure that the yield curve movements are both consistent with current market yield curves and such that no riskless arbitrage is possible. The Heath-Jarrow-Morton framework was developed in the early 1990s by David Heath of Cornell University, Andrew Morton of Lehman Brothers, and Robert A. Jarrow of Kamakura Corporation and Cornell University. The US dollar yield curve as of 9 February 2005. ... Heath-Jarrow-Morton framework is a general framework to model the evolution of interest rates (forward rates in particular). ... The US dollar yield curve as of 9 February 2005. ... The US dollar yield curve as of 9 February 2005. ... There are very few or no other articles that link to this one. ...

There are a number of standard calculations for measuring the impact of changing interest rates on a portfolio consisting of various assets and liabilities. The most common techniques include:

• 1. Marking to market, calculating the net market value of the assets and liabilities, sometimes called the "market value of portfolio equity"
• 2. Stress testing this market value by shifting the yield curve in a specific way. Duration is a stress test where the yield curve shift is parallel
• 3. Calculating the Value at Risk of the portfolio
• 4. Calculating the multiperiod cash flow or financial accrual income and expense for N periods forward in a deterministic set of future yield curves
• 5. Doing step 4 with random yield curve movements and measuring the probability distribution of cash flows and financial accrual income over time.
• 6. Measuring the mismatch of the interest sensitivity gap of assets and liabilities, by classifying each asset and liability by the timing of interest rate reset or maturity, whichever comes first.

The US dollar yield curve as of 9 February 2005. ... A duration is an amount of time or a particular time interval. ... The US dollar yield curve as of 9 February 2005. ... Definition In economics and finance, the Value at risk, or VaR, is a measure used to estimate how the value of an asset or of a portfolio of assets will decrease over a certain time period (usually over 1 day or 10 days) under usual conditions. ... The US dollar yield curve as of 9 February 2005. ... The US dollar yield curve as of 9 February 2005. ... The interest sensitivity gap was one of the first techniques used in asset liability management to manage interest rate risk. ...

Hedging interest rate risk

Interest rate risks can be hedged using fixed income instruments or interest rate swaps. Interest rate risk can be reduced by buying bonds with shorter duration, or by entering into a fixed-for-floating interest rate swap. In the field of derivatives trading, a popular form of swap is the interest rate swap, in which one party exchanges a stream of interest for another stream. ...

External links

• riskglossary.com Article on interest rate risk.

See also

• Bond convexity
• Credit risk
• Bond duration
• Immunization (finance)
• Legal risk
• Liquidity risk
• Market risk
• Operational risk
• Settlement risk
• Volatility risk
• Risk modeling
• Yield curve