Financial Terms
Interest Rate Risk

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Definition of Interest Rate Risk

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Interest Rate Risk

Possibility that interest rates will rise during the term of a loan thereby increasing the annual cost of borrowing.

Interest rate risk

The risk that a security's value changes due to a change in interest rates. For example, a
bond's price drops as interest rates rise. For a depository institution, also called funding risk, the risk that
spread income will suffer because of a change in interest rates.

Related Terms:

Funding risk

Related: interest rate risk

Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

Accelerated depreciation

Any depreciation method that produces larger deductions for depreciation in the
early years of a project's life. Accelerated cost recovery system (ACRS), which is a depreciation schedule
allowed for tax purposes, is one such example.

accelerated depreciation

(1) The estimated useful life of the fixed asset being depreciated is
shorter than a realistic forecast of its probable actual service life;
(2) more of the total cost of the fixed asset is allocated to the first
half of its useful life than to the second half (i.e., there is a
front-end loading of depreciation expense).

Accelerated depreciation

Any of several methods that recognize an increased amount
of depreciation in the earliest years of asset usage. This results in increased tax benefits
in the first few years of asset usage.

Accounting rate of return (ARR)

A method of investment appraisal that measures
the profit generated as a percentage of the
investment – see return on investment.

Interest Rate Risk Image 2

accounting rate of return (ARR)

the rate of earnings obtained on the average capital investment over the life of a capital project; computed as average annual profits divided by average investment; not based on cash flow

Accrued interest

The accumulated coupon interest earned but not yet paid to the seller of a bond by the
buyer (unless the bond is in default).

Accrued Interest

The amount of interest accumulated on a debt security between
interest paying dates

Accrued Interest

The amount of interest owing but not paid.

Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a
better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy

Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.

After-tax real rate of return

Money after-tax rate of return minus the inflation rate.

All equity rate

The discount rate that reflects only the business risks of a project and abstracts from the
effects of financing.

Amortizing interest rate swap

Swap in which the principal or national amount rises (falls) as interest rates
rise (decline).

Interest Rate Risk Image 3

Annual percentage rate (APR)

The periodic rate times the number of periods in a year. For example, a 5%
quarterly return has an APR of 20%.

annual percentage rate (APR)

interest rate that is annualized using simple interest.

Arithmetic average (mean) rate of return

Arithmetic mean return.

Asset-specific Risk

The amount of total risk that can be eliminated by diversification by
creating a portfolio. Also known as company-specific risk or
unsystematic risk.

Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.

Average rate of return (ARR)

The ratio of the average cash inflow to the amount invested.

Average tax rate

Taxes as a fraction of income; total taxes divided by total taxable income.

average tax rate

Total taxes owed divided by total income.

Bankruptcy risk

The risk that a firm will be unable to meet its debt obligations. Also referred to as default or insolvency risk.

Barbell strategy

A strategy in which the maturities of the securities included in the portfolio are concentrated
at two extremes.

Base interest rate

Related: Benchmark interest rate.

Basic business strategies

Key strategies a firm intends to pursue in carrying out its business plan.

Basis risk

The uncertainty about the basis at the time a hedge may be lifted. Hedging substitutes basis risk for
price risk.

Benchmark interest rate

Also called the base interest rate, it is the minimum interest rate investors will
demand for investing in a non-Treasury security. It is also tied to the yield to maturity offered on a
comparable-maturity Treasury security that was most recently issued ("on-the-run").

Best-interests-of-creditors test

The requirement that a claim holder voting against a plan of reorganization
must receive at least as much as he would have if the debtor were liquidated.

Beta risk

risk of a firm measured from the standpoint of an investor who holds a highly diversified portfolio.

Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees

A committee formed in response to SEC chairman Arthur Levitt's initiative to improve the financial
reporting environment in the United States. In a report dated February 1999, the committee
made recommendations for new rules for regulation of financial reporting in the United States that
either duplicated or carried forward the recommendations of the Treadway Commission.

book rate of return

Accounting income divided by book value.
Also called accounting rate of return.

Break-even payment rate

The prepayment rate of a MBS coupon that will produce the same CFY as that of
a predetermined benchmark MBS coupon. Used to identify for coupons higher than the benchmark coupon
the prepayment rate that will produce the same CFY as that of the benchmark coupon; and for coupons lower
than the benchmark coupon the lowest prepayment rate that will do so.

Break-even tax rate

The tax rate at which a party to a prospective transaction is indifferent between entering
into and not entering into the transaction.

Broker loan rate

Related: Call money rate.

Bullet strategy

A strategy in which a portfolio is constructed so that the maturities of its securities are highly
concentrated at one point on the yield curve.

Business risk

The risk that the cash flow of an issuer will be impaired because of adverse economic
conditions, making it difficult for the issuer to meet its operating expenses.

Buy-and-hold strategy

A passive investment strategy with no active buying and selling of stocks from the
time the portfolio is created until the end of the investment horizon.

Call money rate

Also called the broker loan rate , the interest rate that banks charge brokers to finance
margin loans to investors. The broker charges the investor the call money rate plus a service charge.

Call risk

The combination of cash flow uncertainty and reinvestment risk introduced by a call provision.

Capitalization Rate

A discount rate used to find the present value of a series of future cash receipts. Sometimes called discount rate.

Capitalized interest

interest that is not immediately expensed, but rather is considered as an asset and is then
amortized through the income statement over time.

Capitalized Interest

interest incurred during the construction period on monies invested in
assets under construction that is added to the cost of the assets.

cash burn rate

A relatively recent term that refers to how fast a business
is using up its available cash, especially when its cash flow from operating
activities is negative instead of positive. This term most often refers
to a business struggling through its start-up or early phases that has not
yet generated enough cash inflow from sales to cover its cash outflow for
expenses (and perhaps never will).

Cash flow after interest and taxes

Net income plus depreciation.

Combination strategy

A strategy in which a put and with the same strike price and expiration are either both
bought or both sold. Related: Straddle

Commercial risk

The risk that a foreign debtor will be unable to pay its debts because of business events,
such as bankruptcy.

Company-specific risk

Related: Unsystematic risk

Companyspecific Risk

See asset-specific risk

compensation strategy

a foundation for the compensation plan that addresses the role compensation should play in the organization

Completion risk

The risk that a project will not be brought into operation successfully.

Compound interest

interest paid on previously earned interest as well as on the principal.

Compound Interest

interest paid on principal and on interest earned in previous

compound interest

a method of determining interest in which interest that was earned in prior periods is added to the original investment so that, in each successive period, interest is earned on both principal and interest

compound interest

interest earned on interest.

Compound Interest

interest earned on an investment at periodic intervals and added to principal and previous interest earned. Each time new interest earned is calculated it is on a combined total of principal and previous interest earned. Essentially, interest is paid on top of interest.

computer integrated manufacturing (CIM)

the integration of two or more flexible manufacturing systems through the use of a host computer and an information networking system

confrontation strategy

an organizational strategy in which company management decides to confront, rather than avoid, competition; an organizational strategy in which company management still attempts to differentiate company
products through new features or to develop a price
leadership position by dropping prices, even though management
recognizes that competitors will rapidly bring out
similar products and match price changes; an organizational
strategy in which company management identifies
and exploits current opportunities for competitive advantage
in recognition of the fact that those opportunities will
soon be eliminated


A firm engaged in two or more unrelated businesses.

Conglomerate merger

A merger involving two or more firms that are in unrelated businesses.

Contribution Rate

The percentage tax charged by a state to an employer to
cover its share of the state unemployment insurance fund.

Corporate acquisition

The acquisition of one firm by anther firm.

Corporate bonds

Debt obligations issued by corporations.

Corporate charter

A legal document creating a corporation.

Corporate finance

One of the three areas of the discipline of finance. It deals with the operation of the firm
(both the investment decision and the financing decision) from that firm's point of view.

Corporate financial management

The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.

Corporate financial planning

Financial planning conducted by a firm that encompasses preparation of both
long- and short-term financial plans.

Corporate processing float

The time that elapses between receipt of payment from a customer and the
depositing of the customer's check in the firm's bank account; the time required to process customer

Corporate tax view

The argument that double (corporate and individual) taxation of equity returns makes
debt a cheaper financing method.

Corporate taxable equivalent

rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.

cost leadership strategy

a plan to achieve the position in a
competitive environment of being the low cost producer of
a product or provider of a service; it provides one method
of avoiding competition

Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk
to the option buyer that the option writer will not buy or sell the underlying as agreed.
Country economic risk Developments in a national economy that can affect the outcome of an international
financial transaction.

Country financial risk

The ability of the national economy to generate enough foreign exchange to meet
payments of interest and principal on its foreign debt.

Country risk General

Level of political and economic uncertainty in a country affecting the value of loans or
investments in that country.

Coupon rate

In bonds, notes or other fixed income securities, the stated percentage rate of interest, usually
paid twice a year.

Coupon Rate

The rate of interest paid on a debt security. Generally stated on an
annual basis, even if the payments are made at some other

Coupon rate

The nominal interest rate that the issuer promises to pay the
buyer of a bond.

coupon rate

Annual interest payment as a percentage of face value.

Covered call writing strategy

A strategy that involves writing a call option on securities that the investor
owns in his or her portfolio. See covered or hedge option strategies.

Covered interest arbitrage

A portfolio manager invests dollars in an instrument denominated in a foreign
currency and hedges his resulting foreign exchange risk by selling the proceeds of the investment forward for

Covered or hedge option strategies

Strategies that involve a position in an option as well as a position in the
underlying stock, designed so that one position will help offset any unfavorable price movement in the other,
including covered call writing and protective put buying. Related: naked strategies

Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the
payment may not be made on a negotiable instrument. Related: Default risk

Credit Risk

Financial and moral risk that an obligation will not be paid and a loss will result.

Crediting rate

The interest rate offered on an investment type insurance policy.

Cross-border risk

Refers to the volatility of returns on international investments caused by events associated
with a particular country as opposed to events associated solely with a particular economic or financial agent.

Cross rates

The exchange rate between two currencies expressed as the ratio of two foreign exchange rates
that are both expressed in terms of a third currency.

Crossover rate

The return at which two alternative projects have the same net present value.

Currency risk

Related: Exchange rate risk

Currency risk sharing

An agreement by the parties to a transaction to share the currency risk associated with
the transaction. The arrangement involves a customized hedge contract embedded in the underlying

Current rate method

Under this currency translation method, all foreign currency balance-sheet and income
statement items are translated at the current exchange rate.

Daily Interest Accumulation

Account in which interest is accrued daily and credited to the account at the end of a specified time.

Dedication strategy

Refers to multi-period cash flow matching.

Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an
issuer of a bond may be unable to make timely principal and interest payments.

differentiation strategy

a technique for avoiding competition by distinguishing a product or service from that of competitors through adding sufficient value (including quality and/or features) that customers are willing to pay
a higher price than that charged by competitors

discount rate

the rate of return on investment that would be required by a prudent investor to invest in an asset with a specific level risk. Also, a rate of return used to convert a monetary sum, payable or receivable in the future, into present value.

Discount rate

The interest rate that the Federal Reserve charges a bank to borrow funds when a bank is
temporarily short of funds. Collateral is necessary to borrow, and such borrowing is quite limited because the
Fed views it as a privilege to be used to meet short-term liquidity needs, and not a device to increase earnings.

Discount Rate

The rate of interest used to calculate the present value of a stream
of future cash flows







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