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Test 2 study guide notes

Test 2 study guide notes - Chapter 8 I n terest Rate Risk...

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Chapter 8- Interest Rate Risk I -Determined by: demand and supply for loanable funds -Central Bank (Federal Reserve) is the most important demander/supplier of funds Level and Movement of Interest Rates -Fed. Reserve Board is the US Central bank -their open market operations influence money supply, inflation, and interest rates -Fed lowered interest rates 11 times in response to 9/11 during the year -June 04-August 06 there were inflation concerns -17 consecutive increases in interest rates, some argued they did not raise fast/soon enough Central Bank and Interest Rates -the target is primarily short term rates, focusing on the Fed. Funds rate in particular -changes in interest rates can dramatically effect world interest rates Fed Res Policy during Recent Crisis -fed funds rate reduced from 5.25% to 0-0.25% -bought non-treasury securities Repricing Model -repricing aka funding gap model is based on book value (value doesn’t change w/ int. rates) -model used by small/most DIs in the Us -model has a LOT of weakness, but easy to implement -contrasts market value-based maturity and duration models recommended by the Bank for International Settlements (BIS) -rate sensitivity means that A or L is re-priced at or near current market int. rates w/in a time horizon -Repricing gap is the difference b/t assets and liab. whose int. rates will be re-priced GAP=RSA-RSL (rate sensitive assets-rate sensitive liabilities)
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- refinancing risk is the risk that the cost of rolling over or reborrowing funds will rise above the returns being earned on asset investments -occurs when the GAP is POSITIVE - reinvestment Risk is the risk that the return on funds be reinvested will fall below the cost of the funds -occurs when GAP is NEGATIVE Maturity Buckets -Commerical banks must report repricing gaps for A and L w/ maturies of: -1 day, 1day-3 mo, 3-6mo, 9-12mo, 1-5yrs, over 5yrs -inaccuracies result from maturities of 2 days and 2 months thrown into the same bucket -Cumulative gap for longest maturity is always ZERO
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