RSM428H1 Chapter Notes - Chapter 4: Interest Rate Risk, Yield Curve, Financial Instrument
Document Summary
Interest rate: price for borrowing money for defined period of time. Changes in interest rate lead to changes in value of financial instruments. Variability of value of financial instrument or firm. Arises when future net cash flows do not vary in perfect proportion to interest rates. Not as relevant to banks because they can sell their highly liquid financial assets. Value variability is generally better measure of interest rate risk for banks. May not be best for financial institutions that hold illiquid financial assets or generate volatile streams of fee income. Matching amount and timing of fixed rate assets and liabilities and using derivatives to eliminate any mismatches. Value of many instruments attributable to cash flows prior to maturity. Floating rate instruments reduce/eliminate interest rate risk regardless of maturity. If repricing incomplete (due to caps, floors, lags), repricing interval underestimates interest rate risk. Duration: weighted average repricing interval of individual expected net cash flows.
