mitigate them. Since the risk management process is ongoing, reporting and feedback can be used to refine the system by modifying or improving strategies.

An active decision-making process is an important component of risk management. Decisions about potential loss and risk reduction provide a forum for discussion of important issues and the varying perspectives of stakeholders. Factors that Impact Financial Rates and Prices

Financial rates and prices are affected by a number of factors. It is essential to understand the factors that impact markets because those factors, in turn, impact the potential risk of an organization.

Factors that Affect Interest Rates

Interest rates are a key component in many market prices and an important economic barometer. They are comprised of the real rate plus a component for expected inflation, since inflation reduces the purchasing power of a lender’s assets .The greater the term to maturity, the greater the uncertainty. Interest rates are also reflective of supply and demand for funds and credit risk.

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Interest rates are particularly important to companies and governments because they are the key ingredient in the cost of capital. Most companies and governments require debt financing for expansion and capital projects. When interest rates increase, the impact can be significant on borrowers. Interest rates also affect prices in other financial markets, so their impact is far-reaching.

Other components to the interest rate may include a risk premium to reflect thecreditworthiness of a borrower. For example, the threat of political or sovereign risk can cause interest rates to rise, sometimes substantially, as investors demand additional compensation for the increased risk of default.

Factors that influence the level of market interest rates include:

1、Expected levels of inflation 2、General economic conditions

3、Monetary policy and the stance of the central bank 4、Foreign exchange market activity

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5、Foreign investor demand for debt securities 6、Levels of sovereign debt outstanding 7、Financial and political stability Yield Curve

The yield curve is a graphical representation of yields for a range of terms to maturity. For example, a yield curve might illustrate yields for maturity from one day (overnight) to 30-year terms. Typically, the rates are zero coupon government rates.

Since current interest rates reflect expectations, the yield curve provides useful information about the market’s expectations of future interest rates. Implied interest rates for forward-starting terms can be calculated using the information in the yield curve. For example, using rates for one- and two-year maturities, the expected one-year interest rate beginning in one year’s time can be determined.

The shape of the yield curve is widely analyzed and monitored by market participants. As a gauge of expectations, it is often considered to be a predictor of future economic

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activity and may provide signals of a pending change in economic fundamentals.

The yield curve normally slopes upward with a positive slope, as lenders/investors demand higher rates from borrowers for longer lending terms. Since the chance of a borrower default increases with term to maturity, lenders demand to be compensated accordingly.

Interest rates that make up the yield curve are also affected by the expected rate of inflation. Investors demand at least the expected rate of inflation from borrowers, in addition to lending and risk components. If investors expect future inflation to be higher, they will demand greater premiums for longer terms to compensate for this uncertainty. As a result, the longer the term, the higher the interest rate (all else being equal), resulting in an upward-sloping yield curve.

Occasionally, the demand for short-term funds increases substantially, and short-term interest rates may rise above the level of longer term interest rates. This results in an inversion of the yield curve and a downward slope to its appearance. The high cost of short-term funds detracts from

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gains that would otherwise be obtained through investment and expansion and make the economy vulnerable to slowdown or recession. Eventually, rising interest rates slow the demand for both short-term and long-term funds. A decline in all rates and a return to a normal curve may occur as a result of the slowdown.

Source: Karen A. Horcher, 2005. “What Is Financial Risk Management?”. Essentials

of Financial Risk Management, John Wiley & Sons, Inc.pp.1-22.

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