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Interest Rate Risk

Interest Rate Risk

Definition

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).

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