Interest rate risk:

We discuss some risks arising from changes in the in the interest rates of fixed income securities. Fixed income securities are usually securities that are issued by agencies or organisations that are going in for debt. To proceed with the discussion, we continue where we had left off in Unit about the time value of money and cash flows. We look at some features and characteristics of bonds; however, bonds are but one example. Our discussion in this unit pertains to individuals and organisations that hold fixed-income securities and face risks. These may be individuals who hold bonds, these may be banks as they manage their own assets which include loans that they give out, these may be firms and so on. We have to understand the types of risks that may arise. In the present unit, we discuss interest rate risks. The next unit deals primarily with credit risks.

We begin our discussion in this unit with the features of bonds and their pricing. We develop some concepts related to the main features of bonds and see what kind of risks bondholders can face.  We then go on to explain the concept of market risk, or as it is also called, interest rate risk. We see what it means and what its implications are. Following that, the unit discusses important issues regarding risk strategies and in this context discusses repricing models and what is called GAP analysis. The unit subsequently goes on to deal with aspects of measurement of risk and the attempt to quantify it into a single index. The tool to do this is what is called duration analysis.

Finally, the unit discusses the very important issue of Value at Risk, which is a way of assessing risks by looking at the probability of losses that securities may make.