What is interest rate risk?

What is interest rate risk?

• A. The risk that interest rate changes will affect the value of loans or investments.
• B. The risk that a borrower will default on a loan.
• C. The risk that a bank will go bankrupt.
• D. The risk of identity theft.

Answer: (A)

Interest rate risk is the possibility that changes in market interest rates will alter the value of loans or investments. When rates go up, the present value of a security’s future cash flows declines, so existing fixed-rate assets become less valuable in the market. The impact is bigger for assets with longer maturities or higher duration because their cash flows are more sensitive to rate changes. For banks, this risk affects not just the value of assets but potentially future earnings from those assets and the cost of funds, influencing overall profitability and capital position. Other options describe different risks: default risk is about a borrower not repaying, insolvency risk is about a bank failing, and identity theft is a fraud risk. These are separate from interest rate risk, which centers on how rate movements affect asset values and income.

Interest rate risk is the possibility that changes in market interest rates will alter the value of loans or investments. When rates go up, the present value of a security’s future cash flows declines, so existing fixed-rate assets become less valuable in the market. The impact is bigger for assets with longer maturities or higher duration because their cash flows are more sensitive to rate changes. For banks, this risk affects not just the value of assets but potentially future earnings from those assets and the cost of funds, influencing overall profitability and capital position.

Other options describe different risks: default risk is about a borrower not repaying, insolvency risk is about a bank failing, and identity theft is a fraud risk. These are separate from interest rate risk, which centers on how rate movements affect asset values and income.