Interest rate risk exposure formula
Managing interest-rate risk is, in effect, the adjustment of risk exposure upwards or downwards, which will be in response to ALCO's views on the future direction of interest rates. As part of the risk management process the committee will monitor the current risk exposure and duration gap, using rate sensitivity analysis and simulation modelling to assess whether the current level of risk is satisfactory. Interest rate risk is the chance that an unexpected change in interest rates will negatively affect the value of an investment. The duration of a coupon bond is also affected by its coupon rate. For example, consider a ten-year 20% coupon bond when the interest rate is 10%. Using the same procedure, we find that its duration at the higher 20% coupon rate is 5.98 years versus 6.76 years when the coupon rate is 10%.