Which of the following are accurate statements about interest rate risk? Check all that apply. It arises when the banking system was heavily regulated. It arises because the value of an asset changes when interest rates change. Lately, it has increased due to the growing volatility of interest rates. Changes in interest rates affect only bank liabilities and have no effect on assets.
The Correct Answer and Explanation is:
The accurate statements about interest rate risk are:
- It arises because the value of an asset changes when interest rates change.
- Lately, it has increased due to the growing volatility of interest rates.
Explanation:
Interest Rate Risk:
Interest rate risk refers to the potential impact on the value of assets, liabilities, or financial instruments caused by changes in market interest rates. This risk is primarily relevant to institutions that hold significant fixed-rate financial assets, like bonds or loans, or liabilities with fixed interest rates.
- “It arises when the banking system was heavily regulated”: This statement is incorrect. Interest rate risk can arise under both regulated and unregulated environments. While regulations can affect how banks manage risk, they do not directly cause interest rate risk. Interest rate risk is more about the relationship between interest rates and the market value of assets or liabilities.
- “It arises because the value of an asset changes when interest rates change”: This is correct. The market value of fixed-income assets (like bonds) is inversely related to interest rates. When interest rates rise, the value of fixed-income assets tends to fall, and vice versa. This change in value is a key aspect of interest rate risk for financial institutions.
- “Lately, it has increased due to the growing volatility of interest rates”: This statement is correct. In recent years, interest rate volatility has increased due to shifts in economic conditions, central bank policies, and global events. As a result, banks and investors face more uncertainty regarding the future movements of interest rates, which raises the level of interest rate risk.
- “Changes in interest rates affect only bank liabilities and have no effect on assets”: This is incorrect. Interest rate changes affect both assets and liabilities. For example, a bank holding fixed-rate loans will see the value of its assets change if interest rates rise or fall. Similarly, changes in rates will also affect the cost of borrowing for the bank, which influences liabilities.
In summary, interest rate risk is a result of the impact that interest rate changes have on the value of assets and liabilities, and it has grown more pronounced with recent rate volatility.
