What is interest rate risk? - letsdiskuss
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@Blogger | Posted on | Share-Market-Finance


What is interest rate risk?


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@Blogger | Posted on




The simplest form of interest risk is the risk that the value of a fixed income security will fall as a result of an increase in interest rates. But in complex portfolios of interest rate sensitive assets, many different kinds of exposure can from differences in the maturity and reset dates of instruments and cash flows that are like and those that are liability like.

In particular, "curve" risk and arise in portfolios in which longand short positions of different maturities are effectively hedged against a parallel shift in yields but not against a change in the shape of yield curve. Meanwhile, even when off setting positions have the same maturity, basis risk can arise if the rates of the positions are imperfectly correlated.

For example, 3 month Eurodollar instruments and three month treasury bills both naturally pay 3 month interest rates are not perfectly correlated each other, and spreads between their yields may vary over time. As a result, a 3 month Treasury Bill funded by 3 month Eurodollar deposits represents an imperfect offset or hedged position.
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