Unformatted text preview: Asset & Liability Management Asset & the Yield Curve the
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 Chapter 5 4 1 2
1 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 Managing With Discount Rate Managing Expectations Expectations
– – – – Market liquidity Default risk Taxability Call risk • Discount rates differ due to: • Yield curve plots current yields on either Yield U. S. Treasury coupon or strip securities against their maturities. + against 4 1 2
2 Measuring Interest Rate Risk
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Unexpected changes in interest rates can have a Unexpected material effect on a bank’s profitability & market value of equity. market • Interest rate risk encompasses this volatility. • Depending on cash flow from a bank’s balance Depending sheet, interest rate changes may raise or lower net interest income & the market value of assets & liabilities. + liabilities. 4 1 2
3 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 Gap Analysis: Measuring Net Gap Interest Income & NearTerm Cash Flows Flows
• GAP models focus on managing net interest GAP income in the short run. income • Typical objective is to measure expected Typical net interest income & identify strategies to stabilize or improve it. stabilize • Interest rate risk is measured by calculating Interest GAPs over different time intervals using aggregate balance sheet data at a fixed point in time. + 4 in 4
Continued Continued 1 2 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Gap values are then examined to infer how Gap much net interest income will change if rates change. change. • Static GAP analysis considers the range of Static outcomes when GAP values are held constant. outcomes • Dynamic GAP analysis allows GAP values to change along with changes in interest rates. + Gap Analysis: Measuring Net Gap Interest Income & NearTerm Cash Flows Flows 4 1 2
5 Static Gap Analysis
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Four basic steps to static GAP analysis: – Management selects a time frame for determining if Management assets & liabilities are rate sensitive or fixedrate. assets – Assets & liabilities are grouped into time “buckets” Assets or intervals according to maturity or time until first possible repricing. possible – The GAP then equals the dollar difference in ratesensitive assets (RSAs) & ratesensitive liabilities sensitive (RSLs) for each time interval. + (RSLs) 4
Continued 1 2
6 Static Gap Analysis
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 – Management interprets GAP information Management directly & indirectly via sensitivity analysis. directly
GAP = RSAs  RSLs 4 1 2
7 Dynamic GAP Analysis
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Dynamic GAP analysis follows the same steps Dynamic as static GAP analysis but allows assets & liabilities to differ in their rate sensitivity according to interest rate environment. according • Example: bank has loan at prime floating plus Example: two percent. Loan is capped at 10%. If prime is 7.5% loan is interest sensitive, but if prime is 8%, loan will not reprice above 10%. + 8%, 4 1 2
8 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 What Determines Rate What Sensitivity? Sensitivity? • An asset or liability is normally classified as An ratesensitive within a time interval if: ratesensitive – It matures – It represents an interim, or partial, principal It payment. payment. – The interest rate applied to outstanding principal The changes contractually during the interval; or changes – The outstanding principal can be repriced when The some base rate or index changes & management expects base rate/index to change. + expects 4 1 2
9 GAP Summary
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1
Change in Gap Gap Positive Positive Positive Interest Rates Increase Decrease Change in Interest Income Increase Decrease Increase Decrease Increase Decrease Change in Interest Expense > Increase > Decrease < Increase < Decrease = Increase = Decrease Interest Income Increase Negative Increase Negative Decrease Negative Decrease Zero Zero Zero Increase Decrease Decrease 4
Decrease Decrease Decrease Increase Increase None None None None 1 Change in Net 2
10 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 Changes In Portfolio Changes Composition Composition • Any variation in portfolio mix potentially alters Any net interest income. net • Increase asset rate sensitivity by pricing more Increase loans on floatingrate basis or shorten securities maturities. maturities. • Decrease liability rate sensitivity by Decrease substituting longerterm CDs for overnight federal funds purchased. federal • Both change GAP, interest rate risk, & income. Both 11 + 4 1 2 Strengths: GAP Analysis
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Strengths: – Static GAP easy to understand. – Indicates specific balancde sheet items that are Indicates responsible for the risk. responsible – GAP can be easily calculated once cash flow GAP characteristics are identified. characteristics – Suggests magnitudes of portfolio changes Suggests necessary to alter risk. + necessary 4 1 2
12 Weaknesses: GAP Analysis
• Weaknesses: 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1
– – – Serious ex post measurement errors. GAP analysis ignores the time value of money. Procedure essentially ignores the cumulative Procedure impact of interest rate changes on a bank’s risk position. position. – Liabilities that pay no interest are typically Liabilities ignored in ratesensitivity comparisons. – Static GAP does not capture risk associated Static with options enbedded in securities & bank deposits. + deposits. 13 4 1 2 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 Strategies To Shrink GAP To Strategies Zero Zero • Calculate periodic GAPs over short time intervals. • Match fund repriceable assets with similar Match repriceable liabilities so that periodic GAPs approach zero. approach • Match fund longterm assets with non interestbearing liabilities. • Use offbalance sheet transactions, such as interest Use rate swaps & financial futures, to construct “synthetic” securities and thus hedge. + “synthetic” 4 1 2
14 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 Link Between GAP & Net Link Interest Margin Interest • When GAP is positive, the GAP ratio is greater When than one. than • A negative GAP, in turn, is consistent with a GAP negative ratio of less than one. ratio • Neither GAP or GAP ratio provides direct Neither information on potential variability in earnings when rates change. when • GAP ratio is further deficient because it ignores GAP size. + size.
GAP Ratio = RSAs GAP RSAs RSLs 4 1 2
15 Dynamic GAP Analysis
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Unfortunately, a bank that relies on static GAP Unfortunately, analysis will often observe substantial errors in its forecast of net interest income. This occurs because static GAP ignores important information about the true repricing sensitivity of many assets & liabilities relative to interest rates. liabilities • Dynamic GAP analysis represents an effort to Dynamic recognize that the effective GAP across a time interval is dependent on the level of interest rates & the direction in which rates move. + the
Continued 4 1 2
16 Dynamic GAP Analysis
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Process can be accomplished several ways: – Simplest is to identify those factors that may cause Simplest repricing sensitivity to change & incorporate them in the analysis. in – The popular technology describes assets & The liabilities as having embedded options. + liabilities 4 1 2
17 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 The Duration GAP: Managing The The Market Value of Equity The • Duration GAP (DGAP) models focus on managing Duration net interest income or the market value of stockholders’ equity, recognizing the timing of all individual cash flows. individual • Management’s goal is typically to stabilize or Management’s increase net interest income or the value of the firm. increase • Duration is an attractive measure because it is Duration additive across securities in a portfolio. + additive
Continued 4 1 2
18 0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 The Duration GAP: Managing The The Market Value of Equity The • Aggregate bank interest rate risk is indicated by Aggregate comparing the weighted duration of assets with weighted duration of liabilities. weighted • Management can adjust DGAP to hedge or accept Management interest rate risk by speculating on future interest rate changes. + rate 4 1 2
19 Strengths: Duration GAP
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • Principal attraction to duration analysis is that it provides a comprehensive measure of interest rate risk for the total portfolio. • The smaller absolute value of DGAP, the less sensitive the value of bank equity is to interest rate changes. • Unlike GAP, DGAP recognizes the time value of each cash flow, avoiding the difficulty with time buckets. • Duration analysis takes a longerterm viewpoint & provides managers with greater flexibility in adjusting rate sensitivity. 4 1 2
20 Weaknesses: Duration GAP
0 0 1 1 0 0 1 0 1 0 1 0 1 1 0 1 0 0 0 1 0 1 0 0 1 0 1 1 • It is difficult to compute duration accurately. • To be accurate, duration analysis requires that each To future cash be discounted by a distinct discount rate reflecting the expected future rate at the time the cash flow arises. cash • A bank must continuously monitor & adjust the bank duration of its portfolio. duration • It is difficult to estimate the duration on assets & It liabilities that do not pay interest. + liabilities 4 1 2
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This note was uploaded on 09/30/2010 for the course FIN 468 taught by Professor Bexley during the Fall '10 term at Sam Houston State University.
 Fall '10
 Bexley
 Yield Curve

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