Measuring and Managing Interest Rate Risk: A Primer

Losses from unexpected changes in interest rates have become an increasing problem at depository institutions over the past decade, as interest rates have become more volatile and have climbed to unprecedented levels. Such losses occur when unexpected increases in interest rates decrease the market value of an institution's assets more quickly than the market value of its liabilities-deposits and other borrowed funds This differential change in market values occurs if the institution's assets are less interest sensitive than its deposits, that is, if the earnings rate on assets adjusts more slowly to market changes in interest rates than does the payout-the coupon or contract rate-on deposits.