Interest Rate Risk Management Term Paper

Interest Rate Risk Management

This report aims to discuss the volatility of interest rates and how that issue is important for insurance companies, especially those underwriting premature death risks and selling annuities. The report also presents insights into why interest rates are important for other financial institutions such as banks and corporations who hold interest related securities throughout their accounting processes. Finally, the essay offers a status of the interest rate risk management processes utilized by different corporations and the types of risk management throughout the market. When interest is involved, a major aspect is handled by banks.

Banking is a business that deals with money and other instruments of credit. By money and instruments of credit we mean that although anything can function as money such as dollars, pennies, checks, sea shells and even rocks, it is the process of buying and selling. The idea of money presents an ideal solution for piano salesmen who no longer have to carry around their product for barter. Banks became middlemen in sales transactions in our modern way of thinking to replace the barter systems of old. The real genius in the idea of banks is the concept of interest. Banks created a new way to profit from their middle man status and these concepts arte the foundation of the credit process where banks and other institutions extend loans for longer periods of time in exchange for a payment in the form of interest. There are well over 25,000 banks and near-banks in the United States alone.

Throughout America's history there were a number of financial panics that plagued our nation. In the early 19th century for example, bank failures, business bankruptcies, and long-term economic downturns can be traced to the non-regulated banking systems and because there was little flexibility in the monetary supply.Thus, in 1907 the United States Congress established the National Monetary Commission in an effort to deal with the banking system's issues. Eventually, the Congress passed the Federal Reserve Act around Christmas in 1913. The act established the Federal Reserve Banks and established a more elastic currency that allowed for rediscounting of commercial paper and also establishing new controls over the commercial banking system. The Federal Reserve Act was not a perfect legislation because even today we still see the occasional deficiency such as the International Banking Act of 1978 also called the Humphrey-Hawkins Act which attempted to provide updates such as objectives for the Federal Reserve. These new objectives were efforts to spur economic growth that was more in line with the modern economy's potential to expand and also add stability to the U.S. dollar as well as moderate long-term interest rates.

A major aspect of interest rate risk management stems from the Federal Reserve. The Federal Reserve is actually a Board of Governors in Washington D.C. And also twelve individual regional Federal Reserve Banks. These aspects of the system have a responsibility to conduct our nation's monetary policies by influencing both the money and credit scenarios of the United States economy. There is also an underlying responsibility to regulate commercial banking institutions to ensure the soundness in our overall banking and financial system. The Federal Reserve conducts this risk management through three major tools:

Open market operations to control the level of reserves in the depository system

Setting reserve requirements for depository institutions

Setting the discount rate for lending reserves

The Federal Reserve drives how much it will cost organizations to borrow money. By raising and lowering interest rates for example, the Federal Reserve dictates whether industry….....