# chap8_9 - If Max gets to Heaven he wont last long He will...

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1 “If Max gets to Heaven, he won’t last long. He will be chucked out for trying to pull off a merger between Heaven and Hell…after having secured a controlling interest in key subsidiary companies in both places, of course.” H.G. Wells

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2 The Impact of Unanticipated Changes in Interest Rates: On Profitability Net Interest Income (NII) = Interest Income minus Interest Expense Interest rate risk of NII is measured by the repricing model. (chap. 8) On Market Value of Equity Market Value of Equity = Market Value of Assets minus Market Value of Debt Interest rate risk of equity MV is measured by the duration model. (chap. 9)
3 The Repricing Model Rate Sensitive Assets (Liabilities) RSA/RSL: are repriced within a period of time called a maturity bucket. Repricing occurs whenever either maturity or a roll date is reached. The roll date is the reset date specified in floating rate instruments that determines the new market benchmark rate used to set cash flows (eg., coupon payments). The Federal Reserve set the following 6 maturity buckets: 1 day; 1day-3 months; 3-6 months; 6-12 months; 1-5 yrs; > 5 yrs.

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4 The Repricing Model Repricing Gap (GAP) = RSA – RSL 2200 R = interest rate shock 2200 NII = GAP x R for each maturity bucket i • Cumulative Gap (CGAP) = Σ i GAP i 2200 NII = CGAP x R i where R i is the Gap Ratio = CGAP/Assets
5 Example of Repricing Model Assets \$m Liabilities & Net Worth \$m Short term (1 yr fixed rate) consumer loans 50 Equity Capital (fixed) 20 Long term (2 yrs fixed rate) consumer loans 25 Demand Deposits 40 3 mo. T-bills 30 Passbook savings 30 6 mo. T-bills 35 3 mo. CDs 40 3 yr. T-bonds 70 3 mo. bankers acceptances 20 10 yr, fixed rate mortgages 20 6 mo. commercial paper 60 30 yr. floating rate mortgages (9 mo. adjustment period) 40 1 yr. time deposits 2 yr. time deposits 20 40 TOTAL 270 TOTAL 270

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6 Repricing Ex. (cont.) (1day-3mo] GAP = 30 – (40+20) = -\$30m (3mo-6mo] GAP = 35 – 60 = -\$25m (6mo-12mo] GAP = (50+40) - 20 = \$70m (1yr-5yr] GAP = (25+70) – 40 = \$55m >5 yr GAP = 20 – (20+40+30) = -\$70m 1 yr CGAP = 0-30-25+70 = \$15m 1 yr Gap Ratio = 15/270 = 5.6% 5 yr CGAP = 0-30-25+70+55 = \$70m 5 yr Gap Ratio = 70/270 = 25.9%
7 Assume an across the board 1% increase in interest rates 1 day NII = 0(.01) = 0 (1day-3mo] NII = -\$30m(.01) = -\$300,000 (3mo-6mo] NII = -\$25m(.01) = -\$250,000 (6mo-12mo] NII = \$70m(.01) = \$700,000 (1yr-5yr] NII = \$55m(.01) = \$550,000 >5 yr GAP = -\$70m(.01) = -\$700,000 1 yr C NII = \$15m(.01) = \$150,000 5yr C NII = \$70m(.01) = \$700,000

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## This note was uploaded on 08/27/2011 for the course FINANCE Fixed Inco taught by Professor Proflim during the Three '09 term at University of Adelaide.

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chap8_9 - If Max gets to Heaven he wont last long He will...

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