interest-rate risk

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The risk arising from changes in interest rates. In recent decades the different forms of interest-rate risk have been the subject of much analysis, monitoring, and scrutiny. In the 1980s, for example, the savings and loan associations (S & L) in the USA faced a major crisis as a result of continuing to offer fixed-rate loans despite a steadily climbing interest rate; this meant that their interest revenues remained at a constant level while their interest costs rose. The main forms of interest-rate risk are: the risk that interest-rate changes will impact on the value of fixed-interest assets and liabilities; the risk of mismatches in terms of the repricing of interest on assets and liabilities (as illustrated by the S & L example); prepayment risk, in which a borrower repays an obligation, such as a mortgage, early; the risk that reinvestment may take place at lower rates; and the risk that, as rates rise, repayments will take longer than expected. See gap.

Subjects: Financial Institutions and Services.

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