Interest rate risk is the exposure of a bank's financial condition to adverse movements in interest rates.
Gap: The gap is the difference between the amount of assets and liabilities on which the interest rates are reset during a given period.
Interest rate risk refers to volatility in Net Interest Income (NiI) or in variations in Net Interest Margin (NIM)
The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities.
The risk that the interest rate of different assets and liabilities may change in different magnitudes is called basis risk.
When assets and liabilities fall due to repricing in different periods, they can create a mismatch. Such a mismatch or gap may lead to gain or loss depending upon how interest rate in the market tend to move.
The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities
When the variation in market interest rate causes the Nil to expand, the banks have experienced a favourable basis shift and if the interest rate movement causes the Nil to contract, the basis has moved against the bank.
An yield curve is a line on a graph plotting the yield of all maturities of a particular instrument
Price risk occurs when assets are sold before their maturity dates.
The price risk is closely associated with the trading book which is created for making profit out of short-term movements in interest rates.
Uncertainty with regard to interest rate at which the future cash flows can be reinvested is called reinvestment risk.
When the interest rate goes up, the bonds price decreases
When the interest rate declines the bond price increases resulting in a capital gain but the realised compound yield decreases because of lower coupon reinvestment income.
Duration is a measure of the percentage change in the economic value of a position that will occur, given a small change in the level of interest rates.
Higher duration implies that a given change in the level of interest rates will have a larger impact on economic value.