BK5 - MANA130107 Bank Management 1 Lecture FIVE...

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Unformatted text preview: MANA130107 Bank Management 1 Lecture FIVE Assets-Liability Management (chap 8 ) Topics in Commercial Bank Management MANA130107 Bank Management 2 Assets-Liability Management ¡ Topics covered in this lecture ¢ Derivatives in Assets-Liability Management- Futures- Options- Swaps- Caps, floors and collars MANA130107 Bank Management 3 Steps in Hedging ¡ Identify the spot market risk exposure to reduce ¡ Given the spot market risk, determine whether a long or short futures position is needed ¡ Select the best futures contract ¡ Determine the appropriate number of futures contracts to trade. ¡ Buy or sell the appropriate futures contracts ¡ Determine when to get out of the hedge position, either by reversing the trades (letting contracts expire), or making or taking delivery ¡ Verify that futures trading meets regulatory requirements and the banks internal risk policies MANA130107 Bank Management 4 Short Futures Hedge Process ¡ To hedge a risk from rising interest rate ¡ Protect from higher cost of deposit and borrowings and decrease in the value of existing loans and securities ¡ A liability sensitive bank shall:- Sell a contract with similar repricable period as liabilities today and buy it back in the future to cancel the offsetting positions- Trading gain due to rising interest rate is the difference in the price purchased in the end and price sold at the beginning- This profit can be used to offset the loss from rising cost in deposit and borrowings MANA130107 Bank Management 5 Short Hedge Example ¡ On March 10, 2005, our bank expects to sell a six-month $1 million Eurodollar deposit on August 15, 2005 ¢ The spot market risk exposure is that interest rates may rise and the cost of the Eurodollar deposit will rise by August 2005 ¢ In order to hedge, the bank should sell futures contracts now. ¡ The time line of the hedging activities: MANA130107 Bank Management 6 Long Futures Hedge Process ¡ To hedge a risk from falling interest rate ¡ Protect from lower earnings from now loans and securities ¡ An assets sensitive bank shall:- Buy a contract with similar repricable period as assets (cash inflow) today and sell it in the future to cancel the offsetting positions- Trading gain due to falling interest rate is the difference in the sold price in the end and purchasing price at the beginning- This profit can be used to offset the opportunity cost from falling revenue in loans and security holdings MANA130107 Bank Management 7 Long Hedge Example ¡ On March 10, 2005, our bank expects to receive a $1 million payment on November 8, 2005, and anticipates investing the funds in 3-month Eurodollar time deposits ¢ The spot market risk exposure is that the bank will not have access to the funds for eight months....
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BK5 - MANA130107 Bank Management 1 Lecture FIVE...

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