Rollover Risk is a type of financial risk involving the potential losses that can occur when a loan or debt instrument is rolled over. Rollover risk is generally associated with the refinancing of a loan, where the interest rate charged for the new loan is higher than for the old loan. Rollover risk is typically associated with the length of the loan term and the likelihood that the borrower will be able to obtain funding at a lower rate when the loan’s current term expires. As loan terms increase, so does the risk that rates on a new loan will increase and thereby, the borrower’s debt will be more costly than anticipated when initially borrowing the money.

The term “rollover risk” can also be applied to derivatives positions, in which case it refers to the risk that a derivatives position will lose value when rolled to a new maturity. This risk is also affected by economic conditions such as liquidity in the marketplace and access to credit, as well as the borrower’s financial condition.

Rollover risk can be mitigated by understanding market conditions, setting up appropriate hedging strategies, and monitoring liquidity. Borrowers should also watch market trends closely, in order to determine whether or not their current loan is the most cost-effective option or whether it makes sense to refinance to obtain a lower rate. Additionally, borrowers might want to consider using some form of liquidity protection such as a line of credit to offset any unpleasant surprises that could occur due to higher market interest rates.

In short, rollover risk is a reality that borrowers should consider when entering new loan arrangements. Managing rollover risk involves keeping an eye on rising interest rates and changing market conditions, understanding how these factors might affect the costs of refinancing a loan, and setting up hedges where appropriate. By doing so, borrowers can reduce the risk of bigger losses down the road should they need to roll a loan over at a higher rate than they had originally anticipated.