A Risk Professional's Survival Guide: Applied Best Practices in Risk Management

CHAPTER 9 Interest Rate Risk

OVERVIEW OF SIFIBANK’S INTEREST RATE RISK EXPOSURE

SifiBank’s Fixed Income Division (SFID) was established within the Treasury office of SifiBank to invest excess cash from the bank in fixed-income securities. SFID is permitted to invest only in high-quality sovereign, government-sponsored, or corporate debt with at least AA-ratings according to two nationally recognized statistical rating organizations (NRSROs) such as S&P. Currently SFID has a portfolio of $62 billion allocated in the investments shown in Table 9.1. SFID’s investments are largely a buy-and-hold strategy so the bank is not concerned about price or market risk, as would be the case in SifiBank’s trading division. However, SFID is exposed to interest rate risk. Interest rate risk arises from a mismatch in the maturity between the assets and liabilities. This imbalance can have negative effects on the income stream of the firm as well as on the market value of assets and liabilities. In the case of fixed-income instruments like Treasury securities that do not have any embedded options such as prepayment, the price of a bond moves inversely with its yield. As interest rates rise, this lowers the price of the bond and the maturity of the bond plays a significant role in determining how much of a decline in value is realized. It is this change in market value dimension of interest rate risk that SFID is most concerned about since it does not have liabilities to directly manage. If it ...