Interest Rate Sensitivity

Interest rate sensitivity is a measure of how much the value of an asset or liability will change in response to a change in interest rates. This can be an important factor for investors and financial institutions to consider when making investment decisions.

There are two main types of interest rate sensitivity:

• Price sensitivity: This refers to the change in the price of an asset or liability in response to a change in interest rates. For example, a bond with a higher coupon rate will be more sensitive to interest rate changes than a bond with a lower coupon rate.
• Cash flow sensitivity: This refers to the change in the cash flows of an asset or liability in response to a change in interest rates. For example, a mortgage with a variable interest rate will be more sensitive to interest rate changes than a mortgage with a fixed interest rate.

Interest rate sensitivity can be calculated using a variety of methods. One common method is to use the duration of an asset or liability. Duration is a measure of the weighted average time until an asset or liability makes a cash flow. The longer the duration, the more sensitive the asset or liability will be to interest rate changes.

Interest rate sensitivity is an important factor to consider for investors and financial institutions. By understanding how interest rate changes can affect the value of their assets and liabilities, they can make more informed investment decisions.

Here are some additional examples of how interest rate sensitivity can impact different types of assets and liabilities:

• A bond with a fixed interest rate will be less sensitive to interest rate changes than a bond with a variable interest rate. This is because the cash flows of a bond with a fixed interest rate are not affected by changes in interest rates.
• A mortgage with a variable interest rate will be more sensitive to interest rate changes than a mortgage with a fixed interest rate. This is because the interest rate on a variable rate mortgage can change at any time, which can affect the monthly payments and the total amount of interest paid over the life of the loan.
• A stock with a high dividend yield will be more sensitive to interest rate changes than a stock with a low dividend yield. This is because the dividend yield of a stock is affected by the interest rate environment. When interest rates are high, investors are more likely to invest in bonds, which have a higher yield than stocks. This can lead to a decline in the stock price and a decrease in the dividend yield.

Interest rate sensitivity is a complex topic, and there are many factors that can affect the interest rate sensitivity of an asset or liability. It is important to understand these factors before making any investment decisions.