I understand very well how the fixed-rate lender (ie. holding long-term bonds) is subject to market value risk, and how the variable-rate lender (ie. rolling over short term bonds) is less so, but subjected to cash flow risk. But now flip the coin and consider you’re the borrower. I would think, intuitively, it would be the opposite. If I’m a fixed rate borrower (30 years @ 4.375%, gotta love it!) then my fixed rate is a liability, and presumably assets that I hold are going to be some mixture, but at least in part they are floating. Thus it seems reasonable to me that I’m taking on cash flow risk because I have variable rate assets and fixed rate liabilities. Am I overthinking this? I couldn’t find where the CFAI text was explicit, but Schweser seems to treat fixed rate instruments as market value risky to both counterparties and variable rate instruments as cash flow risky to both counterparties.
if I am a fixed rate borrower - I know exactly what my cash flow per period needs to be. so there is no cash flow risk. However, you are at the mercy of the interest rate gods - who could increase the market interest rate.
The cash flow risk is only shown in Reading 43(RM/Swap), not in any other places. Cash flow risk is a common risk in floating bonds. Any way to measure it?
Whether I am a floating rate lender or borrower, it doesn’t matter. I will always have cash flow risk as my income/pmt will not know until reset date. If I am a fixed rate borrower, I run the risk of rates decreasing. If I am a fixed rate lender, I run the risk of rates increasing. Both are market value risks.
Both market value risk and cash flow risk are market risks, am I right? A: fixed rate bond. (market value risk) B: floating rate bond.(cash flow risk) The buyer of A and the issuer of B are concerned about the increasing of interest rate. The buyer of B and the issuer of A are concerned about the decreasing of interest rate.