interest rate risk
Interest rate risk is the risk associated with any contractual agreement
or financial transaction wherein interest income on liquid assets (1) is critical
to the success of the transaction and (2) the future value of which is not known
or guaranteed. Interest rate risk may be borne by one or both counterparties
to a transaction. In some transactions, the seller of the service assumes the
interest rate risk but charges the customer a fee based on some estimate of
the degree of risk assumed. Banks are subject to severe interest rate risk since
the slightest movement in critical rates can produce significant gains or losses.
Banks often use derivative hedges to limit the volatility of interest rates,
thus mitigating the risk (by removing or diminishing the second definition above).