Introduction to Finance

interest rate risk 
possible price 
fl uctuations in fi xed rate debt 
instruments associated with 
changes in market interest rates
4
There is an inverse relationship between the price or value of debt instruments and interest rates. When market 
interest rates increase, debt instruments go down in value, and vice versa.

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70
C H A PT E R 3 Banks and Other Financial Institutions
trust-preferred securities, and provide for loan-loss reserves in the event that loans have to be 
written off . Trust-preferred securities have both debt and equity characteristics in that an issuing 
bank creates a trust, issues debt to the trust, and then sells preferred stock to investors. Tier 1 cap-
ital is composed of common equity, noncumulative preferred stock, and trust-preferred securities, 
minus intangible assets. Tier 2 capital is a bank’s loan-loss reserve amount plus other qualifying 
securities (e.g., subordinated debt and perpetual preferred stock) plus net unrealized gains on 
marketable securities. Total capital is the sum of tier 1 and tier 2 capital.
The central banks and other national supervisory authorities of major industrialized 
countries met in Basel, Switzerland, in mid-1988 (
Basel I Accord
), in 2003 (
Basel II 
Accord
), and again in 2010 (
Basel III Accord
). The objectives were to improve risk meas-
urement and management of large internationally involved banks, and to improve the trans-
parency of bank riskiness to customers and other constituencies. As a result, the Bank for 
International Settlements (BIS) established capital adequacy requirements for banks with 
international operations, based on the use of risk-weighted assets. The weightings were 
established as follows:
Bank Assets