how rollover risk works
also known as roll risk rollover risk is sometimes used interchangeably with refinancing risk however it s actually more of a sub category of that refinancing risk is a more general term referring to the possibility of a borrower being unable to replace an existing loan with a new one rollover risk deals more specifically with the adverse effect of rolling over or refinancing debt this effect has more to do with prevailing economic conditions specifically interest rate trends and the liquidity of credit than the financial condition of the borrower for example if the u s had 1 trillion dollars of debt it needed to roll over in the next year and interest rates suddenly rose 2 higher before the new debt was issued it would cost the government a lot more in new interest payments special considerationsthe state of the economy is also significant lenders are often unwilling to renew expiring loans during a financial crisis when collateral values drop especially if they are short term loans that is their remaining maturity is less than one year so along with the economy the nature of the debt can matter according to a 2012 article rollover risk and credit risk published in the journal of finance 1derivatives roll riskrollover risk also exists in derivatives where futures or options contracts must be rolled over to later maturities as near term contracts expire in order to preserve one s market position if this process will incur a cost or lose money it poses a risk in particular it refers to the possibility that a hedge position will expire at a loss necessitating a cash payment when the expiring hedge is replaced with a new one in other words if a trader wants to hold a futures contract until its maturity and then replace it with a new similar contract they run the risk of the new contract costing more than the old paying a premium to extend the position example of rollover riskat the beginning of october 2018 the world bank issued concerns about two asian nations rollover risks are potentially acute for indonesia and thailand given their sizable stocks of short term debt around 50 billion and 63 billion respectively it stated 2the world bank s concerns had reflected the fact that central banks around the world had been tightening credit and raising interest rates following the lead of the u s federal reserve which had increased the federal funds rate steadily between 2015 and december 2018 from near 0 to 2 25 resulting in billions in u s and foreign investments being pulled from both countries 3however between 2008 and 2021 interest rates fell as the fed cut the federal funds rate to a range of 0 0 to 0 25 4 the move was made to support the economy amid the 2020 economic crisis following the global covid 19 pandemic 5 however 2022 saw increased inflation and the fed was forced to raise interest rates this can result in renewed rollover risk 