INTEREST RATE RISK
This article covers the Interest Rate Risk of CAIIB NOV 2022 Risk Management and CAIIB Nov 2022 Study Material.
CAIIB NOV 2022 EXAM
The IIBF administers the CAIIB exam twice a year. The IIBF, established in 1928, presently includes more than 700 financial institutions.
- One of the top exams offered by the IIBF is CAIIB which is used to choose the best candidates from among the officers already serving as representatives of the IIBF in the field of IT, Central Banking, Retail Banking & many others.
- On November 27, December 4, and December 10, 2022, the CAIIB Exam will be held.
- Advanced decision-making, risk management, and general bank management knowledge and abilities are part of CAIIB EXAM’s scope.
- This Exam is used to evaluate general banking administration and sophisticated decision-making techniques.
- Two required subjects and one optional subject make up this Exam.
CAIIB NOV 2022 RISK MANAGEMENT:
Despite being a relatively recent practice in Indian banks, risk management has already been demonstrated to improve the effectiveness of the banks’ governance, as such procedures tend to enhance a financial institution’s corporate governance. Financial institutions must demonstrate their mettle in market volatility and fluctuations by enduring the changes and achieving sustainability in terms of growth, and having a stable share value. Therefore, minimizing the risks and benefits associated with the products and services the bank offers would be a crucial part of any risk management framework. To account for internal and external risks, a strong framework for risk management is also essential.
WHAT IS INTEREST RATE RISK?
- The danger of investment losses brought on by a change in interest rates is known as interest rate risk. For instance, the value of a bond or other fixed-income investment will decrease as interest rates increase. The duration of a bond is the variation in price that results from a change in interest rates.
- By holding bonds with various maturities, investors can lower their exposure to interest rate risk. They can also reduce their exposure by hedging their fixed-income investments with interest rate swaps, options, or other interest rate derivatives.
IMPACT OF INTEREST RATE RISK:
- Changes in interest rates can have an impact on a variety of assets, but they most directly affect the value of bonds and other fixed-income securities. As a result, bondholders keep a close eye on interest rates and base their decisions on how they appear to evolve.
- As interest rates increase, security prices for fixed-income assets decline (and vice versa). This is due to the fact that holding those bonds has a higher opportunity cost when interest rates rise, meaning there is a larger risk of losing out on a superior investment.
- The degree to which a change in interest rates will affect the price is directly related to the security’s tenure. It determines the anticipated change in price due to a 1% change in interest rates. It roughly represents the demand-price elasticity. It is determined by multiplying the cash flow period by the corresponding weights, which are determined based on the cash flow present value.
REDUCING INTEREST RATE RISK:
The interest rate risk is a risk that can be reduced, much like other sorts of hazards. The most popular tools for reducing interest rates include:
- A bondholder can diversify his current portfolio by including securities whose value is less susceptible to interest rate variations if he is concerned about interest rate risk that could negatively affect the value of his holdings (e.g., equity). If an investor simply holds bonds, he can diversify his holdings by combining both short-term and long-term bonds.
- Various hedging techniques can also help to reduce the interest rate risk. The acquisition of various derivatives is usually part of these tactics. Interest rate swaps, options, futures, and forward rate agreements are some of the most popular types (FRAs).
TYPES OF INTEREST RATE RISK:
Three primary subtypes of interest rate risk for banks are defined. All three Interest Rate Risk subtypes have the potential to have an adverse impact on a bank’s financial situation by altering the earnings, costs, or price/value of interest rate-sensitive assets, liabilities, or off-balance sheet items.
- Gap risk, which refers to the risk associated with the timing of instrument rate changes, results from the term structure of banking book instruments. Whether changes in the term structure of interest rates occur consistently across the yield curve (parallel risk) or differently by period determines how much of a gap risk there is (non-parallel risk).
- Basis risk is the term used to characterize the effects of relative changes in interest rates for financial instruments with comparable tenors but differing interest rate indices used in their pricing.
- Option risk can be caused by holdings in derivatives involving options or by optional components that are built into a bank’s assets, liabilities, and/or off-balance sheet items and allow the bank or its client to change the amount and timing of their cash flows. Automatic option risk and behavioural option risk are two more types of option risk.
Read Also: CAIIB RISK MANAGEMENT MOCK TEST 2022
ADVANTAGES OF INTEREST RATE RISK:
- Gain from beneficial changes in interest rates.
- Gain from arbitrage by engaging in various markets.
- By including parties like insurers, a productive market platform is created.
DISADVANTAGES OF INTEREST RATE RISK:
- The possible loss resulting from unforeseen changes in interest rates.
- Costs such as hedging and administration have gone up.
Let’s take an investor who purchases an Rs. 500, 5-year bond with a 3% coupon as an example. After that, interest rates increase to 4%. When fresh bond offerings with more enticing rates hit the market, the investor will find it difficult to sell the bond. Lower prices on the secondary market are partly a result of the decreased demand. The bond’s market value could fall below its original cost of purchasing.
The opposite is also accurate. If interest rates fall below this line, the value of a bond earning 5% increases since the bondholder is guaranteed a favourable fixed rate of return compared to the market.
CAIIB IIBF RISK MANAGEMENT STUDY MATERIAL 2022:
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