Risk is closely related to uncertainty, born out of the probability that something adverse over which one has no control or against which one can not adequately be protected may happen. Risk involves the possibility of a bad outcome or loss. In financial terms, this translates into a loss of income or value.

Interest Rate Risk is the risk which arises due to the uncertainty of future interest rates. It arises due to the difference between the timings of rate changes & the timings of cash flows. (Such risk arises because there is a possibility that when the cash is received, there may be a difference in the prevailing rate of interest and the one agreed upon at the start of the contract) Such changes in interest rate can affect the investments inversely and can be reduced by diversifying the durations of fixed income investments for a specific time period.

This is a risk that directly affects the bondholder because bond prices are interest rate sensitive.

It is also called maturity mismatch risk because the greater the maturity of any investment, greater the change in price for a given change in the interest rates. The risk occurs due to the changes in interest rates that affects the present value of future cash flows. It is based on the bond principle of inverse relationship (i.e., if Interest rates rise, prices falls). Repricing risk also arises due to the maturity mismatch between on balance sheet assets & liabilities & off balance sheet instruments. The repricing risk is analyzed by the gap, duration & scenario techniques.

Basis risk or spread risk is the result which arises due to the change in the relationship between the yields or yield curves of long and short positions with the same maturity in different financial instruments.

Yield curve risk is the result of price changes induced by the changing slope of the yield curve. Such risk usually arises when a liability is matched with a combination of assets that has the same duration but different in cash flows. Maturity yield spread analysis is the technique used to analyse the yield curve risk.

Several management techniques or methods are used to monitor the interest rate risk. Some common are: