Market risk comprises the risk of higher debt servicing costs due to the development in market prices such as interest rates, exchange rates and consumer prices. Market risk management focuses on the risk of higher redemptions and interest payments measured in Danish kroner rather than the risk of changes in the market value of the debt. The reason is that redemptions and interest payments are actual obligations of the central government.
The all-important risk on Danish government debt is interest-rate risk. Interest-rate risk management focuses on the risk of higher interest costs due to the development in interest rates. The decision of the interest-rate risk on the central government debt – typically measured by the duration – is based on long-term projections of the development of interest rate costs, the central government debt's yearly interest rate exposure (interest-rate fixing) and the trade-off between costs and risks based on the Cost-at-Risk (CaR) model.
For 2020, the central government’s interest-rate risk is managed within a target band of 10 years ± 0.5 year for the average duration of the central-government debt, calculated without discounting.
Duration is a summary measure, which does not contain information about the absolute size or the maturity distribution of the interest-rate exposure. Therefore, duration is supplemented with the interest-rate fixing. The interest-rate fixing is the size of the debt for which a new interest rate is to be fixed within a given period of time, e.g. one year. A parallel shift to the yield curve of 1 percentage point will increase interest costs in the given year by approximately 1 per cent of the interest-rate fixing.
The central government holds foreign debt in order to maintain the foreign-exchange reserve and to maintain the central government's market access. Exchange-rate risk is the risk of higher costs (interest as well as redemptions) as a consequence of a change in exchange rates. The end-exposure of the foreign government debt is solely in euro in order to limit the exchange-rate risk. When the central government raises foreign loans in other currencies than euro, the exchange rate exposure on interest payments and redemptions is swapped to euro. This entails a very low exchange-rate risk due to Denmark's fixed exchange-rate policy vis-à-vis the euro.
Inflation risk is the risk of higher redemptions and interest costs as a consequence of the development in consumer prices. Inflation risk is limited as long as only a smaller part of outstanding debt is linked to the consumer price index Higher inflation expectations will affect nominal yields on new nominal debt, but not real yields on inflation-linked debt.