CHAPTER SIX Asset-Liability Management: Determining and Measuring Interest Rates and Controlling a...
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Transcript of CHAPTER SIX Asset-Liability Management: Determining and Measuring Interest Rates and Controlling a...
CHAPTER SIX Asset-Liability Management:
Determining and Measuring Interest Rates and Controlling a Bank’s
Interest-Sensitive And Duration GapsThe purpose of this chapter is to explore the options bankers have today for dealing with risk – especially the risk of loss due to changing interest rates – and to see how a bank’s management cancoordinate the management of its assets with the management of its liabilities in order to achieve the institution’s goals.
6-3
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© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Asset-Liability Management
The Purpose of Asset-Liability Management is to Control a Bank’s Sensitivity to Changes in Market Interest Rates and Limit its Losses in its Net Income or Equity
6-4
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Historical View of Asset-Liability Management
Asset Management Strategy
Liability Management Strategy
Funds Management Strategy
6-5
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Interest Rate Risk
Price RiskWhen Interest Rates Rise, the Market Value of the Bond or Asset Falls
Reinvestment RiskWhen Interest Rates Fall, the Coupon Payments on the Bond are Reinvested at Lower Rates
6-6
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Yield to Maturity (YTM)
n
1tt
t
YTM) (1
CF PriceMarket
6-7
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Bank Discount Rate (DR)
Maturity toDays #
360*
FV
Price Purchase- FV DR
Where: FV equals Face Value
6-8
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Market Interest Rates
Function of:Risk-Free Real Rate of InterestVarious Risk Premiums
Default RiskInflation RiskMarketability RiskCall RiskMaturity Risk
6-9
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Net Interest Margin
Assets Earnings Total
ExpensesInterest - IncomeInterest NIM
6-10
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Goal of Interest Rate Hedging
One Important Goal of Interest Rate Hedging is to Insulate the Bank from the Damaging Effects of Fluctuating Interest Rates
6-11
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Interest-Sensitive Gap Measurements
Dollar Interest-Sensitive Gap
Interest-Sensitive Assets – Interest Sensitive Liabilities
=
Relative Interest-
Sensitive Gap SizeBank
Gap ISDollar
Interest Sensitivity
RatiosLiabilitie SensitiveInterest
Assets SensitiveInterest
6-12
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Interest-Sensitive Assets
Short-Term Securities Issued by the Government and Private BorrowersShort-Term Loans Made by the Bank to Borrowing CustomersVariable-Rate Loans Made by the Bank to Borrowing Customers
6-13
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Interest-Sensitive Liabilities
Borrowings from Money Markets
Short-Term Savings Accounts
Money-Market Deposits
Variable-Rate Deposits
6-14
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Asset-Sensitive Bank Has:
Positive Dollar Interest-Sensitive Gap
Positive Relative Interest-Sensitive Gap
Interest Sensitivity Ratio Greater Than One
6-15
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Liability Sensitive Bank Has:
Negative Dollar Interest-Sensitive Gap
Negative Relative Interest-Sensitive Gap
Interest Sensitivity Ratio Less Than One
6-16
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Gap Positions and the Effect of Interest Rate Changes on the Bank
Asset-Sensitive BankInterest Rates Rise
NIM Rises
Interest Rates FallNIM Falls
Liability-Sensitive BankInterest Rates Rise
NIM Falls
Interest Rates FallNIM Rises
6-17
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Zero Interest-Sensitive Gap
Dollar Interest-Sensitive Gap is ZeroRelative Interest-Sensitive Gap is ZeroInterest Sensitivity Ratio is One
When Interest Rates Change in Either Direction - NIM is Protected and Will Not Change
6-18
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Important Decision Regarding IS Gap
Management Must Choose the Time Period Over Which NIM is to be ManagedManagement Must Choose a Target NIMTo Increase NIM Management Must Either:
Develop Correct Interest Rate ForecastReallocate Assets and Liabilities to Increase Spread
Management Must Choose Dollar Volume of Interest-Sensitive Assets and Liabilities
6-19
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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NIM Influenced By:
Changes in Interest Rates Up or Down
Changes in the Spread Between Assets and Liabilities
Changes in the Volume of Interest-Sensitive Assets and Liabilities
Changes in the Mix of Assets and Liabilities
6-20
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Cumulative Gap
The Total Difference in Dollars Between Those Bank Assets and Liabilities Which Can be Repriced over a Designated Time Period
6-21
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Aggressive Interest-Sensitive Gap Management
Expected Change in Interest Rates
Best Interest-Sensitive Gap
Position
Aggressive Management’s Likely Action
Rising Market Interest Rates
Positive IS Gap Increase in IS Assets
Decrease in IS Liabilities
Falling Market Interest Rates
Negative IS Gap Decrease in IS Assets
Increase in IS Liabilities
6-22
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Problems with Interest-Sensitive Gap Management
Interest Paid on Liabilities Tend to Move Faster than Interest Rates Earned on Assets
Interest Rate Attached to Bank Assets and Liabilities Do Not Move at the Same Speed as Market Interest Rates
Point at Which Some Assets and Liabilities are Repriced is Not Easy to Identify
Interest-Sensitive Gap Does Not Consider the Impact of Changing Interest Rates on Equity Position
6-23
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The Concept of Duration
Duration is the Weighted Average Maturity of a Promised Stream of Future Cash Flows
6-24
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To Calculate Duration
n
1tt
t
n
1tt
t
YTM) (1CFYTM) (1CF *t
D
6-25
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Price Sensitivity of a Security
i) (1
i * D-
P
P
6-26
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Convexity
The Rate of Change in an Asset’s Price or Value Varies with the Level of Interest Rates or Yields
6-27
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Duration of an Asset portfolio
n
1 iAiA i
D *w D
Where:
wi = the dollar amount of the ith asset divided by total assets
DAi = the duration of the ith asset in the portfolio
6-28
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Duration of a Liability Portfolio
n
1iLiL i
D * w D
Where:
wi = the dollar amount of the ith liability divided by total liabilities
DLi = the duration of the ith liability in the portfolio
6-29
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Duration Gap
TA
TL * D - D D LA
6-30
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Change in the Value of a Bank’s Net Worth
L * i) (1
i * D- - A *
i) (1
i * D- NW LA
6-31
McGraw-Hill/IrwinBank Management and Financial Services, 6/e
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Impact of Changing Interest Rates on a Bank’s Net Worth
Positive Rise Decrease
Gap Fall Increase
Negative Rise Increase
Gap Fall Decrease
Zero Rise No Change
Gap Fall No Change
6-32
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Limitations of Duration Gap Management
Finding Assets and Liabilities of the Same Duration Can be DifficultSome Assets and Liabilities May Have Patterns of Cash Flows that are Not Well DefinedCustomer Prepayments May Distort the Expected Cash Flows in DurationCustomer Defaults May Distort the Expected Cash Flows in DurationConvexity Can Cause Problems