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Interest rate risk

Interest rate exposure

On existing loans and deposits:

Loans

 variable rate – risk that interest rates will rise

 fixed rate – risk that interest rates will fall (and so the company can’t take
advantage of the fall)

Deposits

 variable rate – risk that interest rates will fall

 fixed rate – risk that interest rates will rise (and so the company can’t take
advantage of the rise)

Even if a company has matched its variable rate loans against its
variable rate deposits there may still be basis risk if the rates on each
aren’t calculated in the same way.

Basis risk is the risk that investments which, in theory, should offset
each other in terms of changing values, do not do so.

On future loans and deposits:

The risk that interest rates will change before the loan / deposit contract is entered
into.

Gap exposure

 Negative gap – interest-sensitive liabilities maturing at a certain time are greater
than interest-sensitive assets maturing at the same time. Exposure to rising
interest rates.

 Positive gap – interest-sensitive liabilities maturing at a certain time are less
than interest-sensitive assets maturing at the same time. Exposure to falling
interest rates.

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