Skip to content

ACCA Applied Skills · Financial Management · The nature and types of risk and approaches to risk management

A company has a floating-rate bank loan of $20 million and is worried that interest rates will rise. Which of the following is the most direct description of the risk it faces?

The company faces re-pricing interest rate risk. Because the loan rate floats with market rates, any rise in rates increases its interest payments. Fair value risk applies mainly to fixed-rate debt, whose market value changes, not to floating-rate borrowing that resets regularly.

  1. ABasis risk, because the loan rate and the deposit rate may move differently
  2. BGap risk, because the loan may mature before the assets it funds
  3. CRe-pricing (interest rate) risk, because interest costs will increase when market rates riseCorrect
  4. DFair value risk, because the market value of the loan liability will fall when rates rise

Explanation

A floating-rate borrower's interest payments reset to market rates, so rising rates raise the cash cost. This is the re-pricing or cash flow interest rate risk. Fair value risk is the exposure of fixed-rate instruments, so option D is wrong for a floating loan, which stays near par value.

Did you get it right without looking?

One question tells you little. A timed set on The nature and types of risk and approaches to risk management shows your real accuracy, how long you take and where you lose marks.

Practise The nature and types of risk and approaches to risk managementFree diagnostic mock

More The nature and types of risk and approaches to risk management questions