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Risk Measurement and Management: interest rate, liquidity and operational risk - Essay Example
Finance & Accounting
Pages 12 (3012 words)
Name of student: Date due: Risk Measurement and Management 1. Interest rate risk This emerges when the value of an investment will change as a result of change in the absolute level of interest rates, in the range between two interest rates or like the yield curve relationship (Davidson, 2001)…
It affects the value of bonds directly as compared to stocks thus a major risk to all bond holders. The increase in interest rate reduces the bond prices while their decrease inflates the bond prices. Therefore, as interest rate increase, the cost of holding a bond reduces because investor are able to recognize grater yields by opting to other investments that result into high interest rates(Allen, 2004). Interests’ rate risk may emerge as a result of basis risk, yield curve risk, repricing risks and optionality. Measurement These are instruments that help in detecting the level of interest rates to show how the risk can be managed effectively. These measurement tools involve repricing, maturity and duration models. The repricing model This model is also known as the funding gap model whereby a book worth accounting cash flow scrutiny of the repricing gap between the interests revenue gained on assets and the interest spent on liabilities over specific duration. Repricing gap is the variance amid the rate sensitive assets and liabilities (Ahmed, Beatty & Bettinghaus, 2004). Repricing model therefore, illustrates for example how a bank calculates the gaps in each basket by looking at the level of sensitivity of each asset and liability also known as time pricing. ...
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