FHFA-OIG: The Housing Government-Sponsored Enterprises’ Challenges in Managing Interest Rate Risks

FHFA OIG

Summary

Financial institutions that hold mortgage assets in their investment portfolios, such as the GSEs, face two general interestraterisks. First,theyriskincurringlossesiftherateof interest paid on the short-term debt they used to finance the purchase of mortgage assets rises to the level of, or exceeds the rate of, interest earned on those assets. Second, if the interest the GSEs earn on their mortgage assets falls due to declining interest rates, then they face what is known as prepayment risk, i.e., the risk that borrowers will refinance their loans and prepay their mortgages, causing a decline in the institutions’ revenue and income from their mortgage assets.

Financial institutions can manage interest rate risk through several means, including financial instruments known as derivatives, which act as a form of insurance, providing financial protection when rates rise or fall. Derivatives, however, can be complex instruments that require specialized capacity, 
such such as staffing and information systems, to be used effectively.

Full paper below…

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The Housing Government-Sponsored Enterprises’ Challenges in Managing Interest Rate Risks

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