Interest rate risk is the potential impact on companies or investors or investments from a change in interest rates levels. For a company, interest rate risk represents the potential for a lower return on investments if rates fail or higher debt servicing costs if rates rise. Remember, rate risk is not the same as credit risk! Interest rate risk is reflected in the income statement as:. Runaway hikes in interest rates might not be sustainable for a highly-leveraged company and could threaten its bottom line.
The interest coverage ratio measures a company's ability to cope with a growing interest burden. Interest rate risk appears on the balance sheet as a change in the value of a company's assets or liabilities and has a knock-on effect on key financial indicators, such as net debt-to-equity ratio gearing.
Finance departments generally use a specialist treasury management solution TMS to map their exposure to this type of risk. For investors in the financial markets, interest rate risk is the risk that changes in interest rates will reduce the value of an investment.
Take the bond market for example: a bond is a fixed-income investment and bond prices and yields move in opposite directions. If interest rates rise, bond prices fall and vice versa. The second part of the paper extends the model into a model of two countries, two monies and two bonds denominated in these two monies. It is shown, in contrast with statements made in the literature, that the 'efficiency' of international financial markets does not imply equality of expected real interest rates on bonds denominated in different currencies, nor does it imply that the forward exchange rate should be an unbiased predictor of the future spot exchange rate.
This is again true even when there are no outside nominal assets in the world economy. Download Citation Data. The larger duration of longer-term securities means higher interest rate risk for those securities.
To compensate investors for taking on more risk , the expected rates of return on longer-term securities are typically higher than rates on shorter-term securities. This is known as the maturity risk premium. Other risk premiums, such as default risk premiums and liquidity risk premiums, may determine rates offered on bonds.
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