What is Interest Rate Risk?
John Spacey, updated on March 20, 2021
Interest rate risk is the probability that business costs or the value of assets will be negatively affected by changes in interest rates. The price of most assets are sensitive to interest rates and it is common for asset prices to rise or fall as rates change. Interest rates also impact business costs, particularly in capital intensive industries. The following are a few examples of interest rate risks.
1. Asset PricesThe Canadian government suddenly increases interest rates in response to unexpectedly high inflation. The corresponding increased rates for new mortgages make houses less affordable. Buyers leave the market and some homeowners with floating rate mortgages decide to sell as their monthly payments increase. The average selling price for real estate declines across all major Canadian cities resulting in losses for real estate investors.
2. Business CostsA European shipping company that operates on thin margins has large financing needs for its fleet of ships. Interest rates suddenly increase just as the company must refinance some its largest vessels. The increased cost of the new financing terms make the company unprofitable and its stock declines.
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