Final answer:
Financial risk in income-producing properties is related to uncertainties in achieving expected financial results, while interest rate risk involves the effect of changes in market interest rates on investments, such as the impact on the cost of borrowing for properties with debt financing.
Step-by-step explanation:
For income-producing properties, financial risk generally refers to the uncertainty of achieving the expected financial returns due to factors such as changes in market conditions, tenant turnover, or property management issues. This includes, for example, the risk that the income stream from the property could diminish or that the property could decrease in value. On the other hand, interest rate risk pertains to the variability of investment returns linked to changes in the prevailing interest rates. Specifically, for properties with debt financing, changes in interest rates can significantly impact the cost of borrowing and subsequently the property's net income and value. Suppliers of financial capital must weigh these risks against potential rates of return. For instance, if a particular investment displays an increase in risk or a decrease in return, investors are likely to transfer their capital to an alternative investment with a more favorable risk-return profile, causing shifts in supply curves for financial capital between different investments. Understanding these risks is essential for financial institutions as they determine what to pay for loans in the secondary loan market. Greater perceived riskiness of non-repayment results in a lower acquisition price for the loan. Conversely, if an acquired loan has a high interest rate compared to current low market rates, the loan is more valuable to the institution.