Rollover Risk

What Is Rollover Risk?

Rollover risk is a risk associated with the refinancing of debt. Rollover risk is generally looked by countries and companies when a loan or other debt obligation (like a bond) is going to mature and should be changed over, or rolled over, into new debt. In the event that interest rates have increased meanwhile, they would need to refinance their debt at a higher rate and cause more interest charges from now on — or, in case of a bond issue, pay out more in interest.

How Rollover Risk Works

Rollover risk likewise exists in derivatives, where futures or options contracts must be "rolled" over to later maturities as close term contracts lapse to preserve one's market position. On the off chance that this interaction will cause a cost or lose money it represents a risk.

Specifically, it alludes to the possibility that a hedge position will terminate at a loss, requiring a cash payment while the lapsing hedge is supplanted with another one. At the end of the day, if a trader needs to hold a futures contract until its maturity and afterward supplant it with a new, comparative contract, they run the risk of the new contract costing more than the old — paying a premium to expand the position.

Rollover Risk versus Refinancing Risk

Otherwise called "roll risk," rollover risk is now and again utilized conversely with refinancing risk. Notwithstanding, it's to a greater extent a sub-classification of that. Refinancing risk is a more broad term, alluding to the possibility of a borrower being not able to supplant an existing loan with another one. Rollover risk manages the adverse effect of rolling over or refinancing debt.

This effect has more to do with winning economic conditions — explicitly, interest rate trends and the liquidity of credit — than the financial condition of the borrower. For instance, if the U.S. had $1 trillion dollars of debt it expected to roll over in the next year, and interest rates unexpectedly increased 2% higher before the new debt was issued, it would cost the government significantly more in new interest payments.

The state of the economy is additionally critical. Lenders are frequently reluctant to recharge lapsing loans during a financial crisis, when collateral values drop, particularly in the event that they are short-term loans — that is, their excess maturity is short of what one year.

So alongside the economy, the idea of the debt can matter, as per a 2012 article "Rollover Risk and Credit Risk," distributed in The Journal of Finance:

Debt maturity assumes an important part in determining the firm's rollover risk. While shorter maturity for an individual bond decreases its risk, shorter maturity for all bonds issued by a firm compounds its rollover risk by compelling its equity holders to rapidly retain losses incurred by its debt financing.

Illustration of Rollover Risk

Toward the beginning of October 2018, the World Bank issued worries around two Asian nations. "Rollover risks are possibly acute for Indonesia and Thailand, given their sizable stocks of short-term debt (around $50 billion and $63 billion, separately)," it stated.

The World Bank's interests had mirrored the way 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 consistently among 2015 and December 2018, from close 0% to 2.25% — bringing about billions in U.S. furthermore, foreign investments being pulled from the two countries.

Notwithstanding, in the years since, central banks around the world have been bringing down interest rates — following the lead of the Fed, which in March 2020, cut the federal funds rate to a scope of 0.0% to 0.25% for the second time since the 2008 financial crisis. The move was made to support the economy in the midst of the 2020 economic crisis. As of December 2020, the Fed said it expected to keep the fed funds rate in a similar reach until inflation has risen 2% and is on target to moderately surpass 2% for quite a while.

Features

• This risk can likewise allude to the risk that a derivatives position will lose value if and when it is rolled to another maturity.
• Rollover risk is likewise associated with the refinancing of debt — explicitly, that the interest charged for another loan will be higher than that on the old.
• Generally, the shorter-term the developing debt, the greater the borrower's rollover risk.
• Rollover risk reflects economic conditions (for example liquidity and credit markets) versus a borrower's financial condition.