What term describes the risk of fluctuating interest rates affecting loan payments?

What term describes the risk of fluctuating interest rates affecting loan payments?

• A. Market risk
• B. Credit risk
• C. Interest rate risk
• D. Operational risk

Answer: (C)

The risk of fluctuating interest rates affecting loan payments is referred to as interest rate risk. This type of risk emerges primarily because changes in interest rates can directly influence the cost of borrowing and the income generated from investments, particularly in fixed-rate instruments. When interest rates rise, borrowers with variable-rate loans may face higher monthly payments, resulting in increased financial strain. Conversely, if interest rates fall, lenders may see reduced income from existing loans, as they would have to offer new loans at lower rates to remain competitive. Understanding interest rate risk is crucial for both lenders and borrowers, as it can significantly impact cash flow, financial planning, and overall profitability. Market risk involves broader potential losses in investments due to overall market factors, which encompasses interest rate risk but is not limited to it. Credit risk pertains to the possibility of a borrower defaulting on their obligations, while operational risk relates to failures in internal processes, systems, or policies. Therefore, interest rate risk specifically addresses the effects of interest rate fluctuations on loan payments, making it the correct term for this scenario.

The risk of fluctuating interest rates affecting loan payments is referred to as interest rate risk. This type of risk emerges primarily because changes in interest rates can directly influence the cost of borrowing and the income generated from investments, particularly in fixed-rate instruments.

When interest rates rise, borrowers with variable-rate loans may face higher monthly payments, resulting in increased financial strain. Conversely, if interest rates fall, lenders may see reduced income from existing loans, as they would have to offer new loans at lower rates to remain competitive. Understanding interest rate risk is crucial for both lenders and borrowers, as it can significantly impact cash flow, financial planning, and overall profitability.

Market risk involves broader potential losses in investments due to overall market factors, which encompasses interest rate risk but is not limited to it. Credit risk pertains to the possibility of a borrower defaulting on their obligations, while operational risk relates to failures in internal processes, systems, or policies. Therefore, interest rate risk specifically addresses the effects of interest rate fluctuations on loan payments, making it the correct term for this scenario.