Key Components of Interest Rate Risk and Approaches of Risk Management Essay

Key Components of Interest Rate Risk and Approaches of Risk Management for Chinese Banks - Essay Example This paper illustrates that the type of risk tends to affect the stock and bond market in different ways. However, as the interest rate risk impacts the bond market negatively, the investors shift their investment pattern from the bond market to the equity market, influencing the performance of this segment of the financial market. In this paper, the key components of interest rate risk will be analyzed thoroughly. The financial system of China is considered to be one of the highly regulated, involving highly integrated economic and monetary policies. Such regulations and integrations are reflected in the functioning of the banking sector of the country as well. Therefore, for the purpose of analysis, the risk management approaches of the banking sector of China will be critically evaluated. Non- alignments arises in the balance sheet and off-balance sheet items of the banking sectors. In case of fixed interest rate, such mismatches originate at the time of maturity of the financial instrument and in case of variable interest rates; the non-alignments arise at the time of revaluation of an asset, liabilities as well as off-balance sheet instruments. Scope and size of such temporal mismatches make it critical to forecasting changes in interest rate which in turn creates huge interest rate risk. Basis value risk arises out of the asset-liability mismatches. Many times, the correlation between the value of maturities and revaluation of asset- liabilities and their calculative values becomes highly negative because of the adaptation of interest rates. This kind of risk also changes the index rates used for pricing the liabilities and asset that does not really change in a concurrent way and originates huge amount of interest rate risk