What is interest rate risk?
Interest rate risk is the risk that changes in interest rates will have a negative impact on the value of a financial institution’s assets and liabilities. This can lead to a decrease in the institution’s net income, as well as a decrease in its capital levels.
What are the different strategies for controlling interest rate risk?
There are a number of different strategies for controlling interest rate risk. Some of the most common strategies include:
- Asset/liability management: This strategy involves matching the maturities and interest rates of an institution’s assets and liabilities. By matching the maturities of assets and liabilities, an institution can reduce its exposure to repricing risk. By matching the interest rates of assets and liabilities, an institution can reduce its exposure to yield curve risk.
- Hedging: This strategy involves using derivatives to offset the risk of changes in interest rates. For example, an institution can buy interest rate swaps to lock in a fixed interest rate on its liabilities.
- Capital management: This strategy involves maintaining adequate levels of capital to absorb losses due to interest rate risk. By maintaining adequate levels of capital, an institution can reduce its exposure to market risk.
- Risk management framework: This strategy involves developing a comprehensive framework for managing interest rate risk. This framework should include policies, procedures, and tools for measuring, monitoring, and controlling interest rate risk.
Multiple choice questions:
- Which of the following is not a strategy for controlling interest rate risk?
- a. Asset/liability management
- b. Hedging
- c. Capital management
- d. Risk management framework
- Answer: c. Capital management
- Which of the following is the most effective strategy for controlling interest rate risk?
- a. Asset/liability management
- b. Hedging
- c. Capital management
- d. Risk management framework
- Answer: d. Risk management framework
- Which of the following is a derivative that can be used to hedge against interest rate risk?
- a. Interest rate swap
- b. Forward contract
- c. Option
- d. All of the above
- Answer: d. All of the above
- Which of the following is a policy that can be used to control interest rate risk?
- a. Limit the use of derivatives
- b. Require approval for all interest rate sensitive transactions
- c. Monitor interest rate risk on a daily basis
- d. All of the above
- Answer: d. All of the above