Ch_07_IRR_GAP - Managing Interest Rate Risk GAP and Earnings Sensitivity 11 Managing Interest Rate Risk n Interest Rate Risk n The potential loss from

Ch_07_IRR_GAP - Managing Interest Rate Risk GAP and...

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Managing Interest Rate Risk: GAP and Earnings Sensitivity 11
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Managing Interest Rate Risk n Interest Rate Risk n The potential loss from unexpected changes in interest rates which can significantly alter a bank’s profitability and market value of equity 22
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Managing Interest Rate Risk n Interest Rate Risk n When a bank’s assets and liabilities do not reprice at the same time, the result is a change in net interest income n The change in the value of assets and the change in the value of liabilities will also differ, causing a change in the value of stockholder’s equity 33
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Managing Interest Rate Risk n Interest Rate Risk n Banks typically focus on either: n Net interest income or n The market value of stockholders' equity n GAP Analysis n A static measure of risk that is commonly associated with net interest income (margin) targeting n Earnings Sensitivity Analysis n Earnings sensitivity analysis extends 44
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Managing Interest Rate Risk n Interest Rate Risk n Asset and Liability Management Committee (ALCO) n The bank’s ALCO primary responsibility is interest rate risk management. n The ALCO coordinates the bank’s strategies to achieve the optimal risk/reward trade-off 55
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Measuring Interest Rate Risk with GAP n Three general factors potentially cause a bank’s net interest income to change. n Rate Effects n Unexpected changes in interest rates n Composition (Mix) Effects n Changes in the mix, or composition, of assets and/or liabilities n Volume Effects n Changes in the volume of earning assets and interest-bearing liabilities 66
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Measuring Interest Rate Risk with GAP n Consider a bank that makes a $25,000 five-year car loan to a customer at fixed rate of 8.5%. The bank initially funds the car loan with a one-year $25,000 CD at a cost of 4.5%. The bank’s initial spread is 4%. n What is the bank’s risk? 77
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Measuring Interest Rate Risk with GAP n Traditional Static Gap Analysis n Static GAP Analysis GAPt = RSAt - RSLt n RSAt § Rate Sensitive Assets § Those assets that will mature or reprice in a given time period (t) n RSLt § Rate Sensitive Liabilities § Those liabilities that will mature or reprice in a given time period (t) 88
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Measuring Interest Rate Risk with GAP n Traditional Static Gap Analysis n Steps in GAP Analysis 1. Develop an interest rate forecast 2. Select a series of “time buckets” or time intervals for determining when assets and liabilities will reprice 3. Group assets and liabilities into these “buckets” 4. Calculate the GAP for each “bucket ” 5. Forecast the change in net interest income given an assumed change in 99
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Measuring Interest Rate Risk with GAP n What Determines Rate Sensitivity n The initial issue is to determine what features make an asset or liability rate sensitive 1010
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Measuring Interest Rate Risk with GAP n Expected Repricing versus Actual Repricing n In general, an asset or liability is normally classified as rate sensitive within a time interval if: § It matures § It represents an interim or partial principal payment §
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