Bond market risk

Interest rate exposure impacts on the performance of commercial banks, who must seek to match the duration of their interest-bearing assets (loans) with their interest rate liabilities (borrowings). Such a concern leads to consideration of the time “duration” of a loan. Because the market valuation of the interest rates attached to a loan or a bond is determined by the market’s expectation of future interest rates, bond prices provide insight into the market’s prediction for future interest rates. This chapter considers the relation between interest rates and the valuation of an interest-bearing instrument such as a bond. It also considers the concept of a bond’s duration as a measure of interest rate risk exposure. The concept of a bond’s “duration” provides a measure of the bond’s sensitivity to a change in interest rates. Further, the chapter considers the role of the government’s central bank in influencing interest rates.