The Essentials of Risk Management, Second Edition, 2nd Edition

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INTEREST RATE RISK AND HEDGING WITH DERIVATIVE INSTRUMENTS

In this chapter we look at a specific kind of market risk—namely, interest rate risk—and at how institutions can manage the risk arising from particular interest rate positions.

Interest rate risk substantially affects the values of the assets and liabilities of most corporations and is often a dominant factor affecting the values of pension funds, banks, and many other financial intermediaries. According to the Federal Reserve, the total credit market debt (public and private) in the United States at the end of 2012 amounted to $56.3 trillion, most of which was held by the financial sector.¹ Like fixed-interest government bonds, these largely fixed-interest assets fall in value when ...