Topic 12 - Measuring and managing interest rate risk with financial forwards, futures and swaps. In this chapter, students can understand and can recall how DV01, Duration, Convexity, VaR, and Stress Tests are used to measure interest rate risk; how interest rate forwards, futures, and swaps are used to manage interest rate risk. | 1 Topic #12 Measuring and Managing Interest Rate Risk with Financial Forwards, Futures and Swaps L. Gattis A Course in Financial Risk Management 2 What Do Financial Risk Managers Do? (IMM) Identify risks that affects the viability of your firm Market Risks: Equity, Interest Rates, Currency, Commodity Credit Risks: Bond and counterparty default Measure exposure to identified risks Positions, VaR/CaR/EaR, Stress Tests Duration, Convexity, DV01 Mitigate risks Layoff, Accept, Mitigate, Hold Capital 3 Interest Rate Risk Market risk is the exposure to market price and interest rate changes Interest rate risk (IRR) is the exposure to interest rates changes Bond Price Exposure: long bond positions are exposed to rising interest rates (short positions / falling rates) General Rate exposure: All rates falling/rising Spread exposure: spread between asset classes change (., long corporate bonds and short Treasury’s when corporate spreads widen relative to treasury’s) Yield curve exposure: exposure to changes in the shape of the yield curve Borrowing rates: exposed to rising interest rates when need new funding or existing loans/bonds matures ; “Refunding Risk” Investment rates: exposed to lower rates on planned investments or when existing investments mature “Re-investment Risk” Interest rate risk management (IRRM) is the identification, measurement and mitigation of interest rate risk 4 Learning Objectives Students can understand and can recall how DV01, Duration, Convexity, VaR, and Stress Tests are used to measure interest rate risk how interest rate forwards, futures, and swaps are used to manage interest rate risk 5 Refunding Risk and FRAs 120 Days 211 Days rquarterly= rquarterly=2% Borrow 100m +100m -102m Consider the problem of a borrower who wishes to hedge against increases in the cost of borrowing. We consider a firm expecting to borrow $100m for 91 days, beginning in 120 days from today, in June. The loan will be repaid in September on the loan . | 1 Topic #12 Measuring and Managing Interest Rate Risk with Financial Forwards, Futures and Swaps L. Gattis A Course in Financial Risk Management 2 What Do Financial Risk Managers Do? (IMM) Identify risks that affects the viability of your firm Market Risks: Equity, Interest Rates, Currency, Commodity Credit Risks: Bond and counterparty default Measure exposure to identified risks Positions, VaR/CaR/EaR, Stress Tests Duration, Convexity, DV01 Mitigate risks Layoff, Accept, Mitigate, Hold Capital 3 Interest Rate Risk Market risk is the exposure to market price and interest rate changes Interest rate risk (IRR) is the exposure to interest rates changes Bond Price Exposure: long bond positions are exposed to rising interest rates (short positions / falling rates) General Rate exposure: All rates falling/rising Spread exposure: spread between asset classes change (., long corporate bonds and short Treasury’s when corporate spreads widen relative to treasury’s) Yield curve exposure: .
