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Interest Rate Risk Assignment - Essay Example
The simplest, most basic definition as referred to by most theoreticians notes that the interest rate risk is "the risk to earnings or capital arising from movement of interest rates"1. According to the different instruments that the interest rate risk will impact, we can account for a repricing risk, a yield curve risk, a basis risk or an option risk…
Indeed, the credit was sold to the customer at a lower price (lower interest rate) than it could have been if it had been sold at a later time. Certainly, this is one of the simple examples, but we must consider that the value of the bank itself can be directly affected by the interest rate risk, through changes in its overall assets and liabilities values2 and given the time value of money.
The repricing gap model is one of the simplest used by banks to determine the amount of exposure for their assets and is based on "the net differences between interest rate sensitive assets and liabilities maturing at different times"3). Within established time bands (one day, 1 day 3 months, 3-6 months etc. up to assets and liabilities with maturities of over 5 years), total liability values are subtracted from total asset values to evaluate a gap between the two. Each gap value thus obtained can be multiplied by a the assumed change in interest rates in order to obtain the potential numerical expression of the impact the change in interest rates will have on the value of that respective bandwidth (evaluated as the gap between assets and liabilities). ...