Class%20#10%20461%20IRR%20Flows0

Class%20#10%20461%20IRR%20Flows0 - Interest Rate Risk (IRR)...

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Unformatted text preview: Interest Rate Risk (IRR) Interest flows and the WATM gap model 2 CE Presentations TODAY: Christina Tseng and Chad Wherley TUESDAY: Paul Mroz Assignment: Text, Chapter 9 and Appendix 9B Assignment #1 due next Thursday 3 Class Outline 1. Dimensions of interest rate risk 2. Interest rate risk and interest flows Rate sensitive assets and liabilities 2. Defining the repricing gap 3. Improving the gap measureWATM gap 4. Assumptions and limitations of gap measures 4 1. Dimensions of interest rate risk What is interest rate risk ? Interest rates will change . Interest rate risk (IRR) deals with the effects on bank outcomes that will result from these rate changes . Sometimes this is called asset liability management; it has to do with managing the structure of the balance sheet (assets and liabilities) to affect the banks exposure to interest rate risk 5 What happens to a bank when interest rates change? (1) Interest (cash) flows . When interest rates change, the interest flows on some assets and liabilities are affected. These changes in flows translate into changes in things (EPS, net income, net interest income, etc.) that ultimately affect stock price and firm value. (2) Market values of assets and liabilities. These changes translate directly into changes in market value of the firm (its equity). (3) Credit risk . The ability of borrowers to repay the bank may be affected when rates change. 6 2. Interest flows and IRR Interest income (II) comes from interest bearing assets ; interest bearing liabilities give rise to interest expense (IE) . Net interest income ( NII = II - IE ) is the key variable. It is the behavior of NII that we focus on in determining the effect of changes in interest rates. 7 Bank income statement Instead of sales, the top line(s) of a banks income statement show: Interest Income (II)- Interest Expense (IE) = Net Interest Income (NII) Following NII on the Income Statement are other revenue or income items and other expense items, ultimately leading to net income , the bottom line. 8 Interest flows and IRR How and when will the interest income and expense from each of the following assets and liabilities change if interest rates rise now ? 3-month Treasury bill 2-year variable rate loan that reprices monthly 10-year Treasury bond Overnight Fed funds purchased (a liability) 9 Liability interest (cost) flows behave similarly. The cost of an overnight liability will change tomorrow. 0 1 month 2 3 4 5 12 120 Interest from the 3-month T-bill w ill change when a new T-bill at the new rate, replaces the old bill after 3 months. Interest from the 2-year, floating rate loan, w ill change when the loan 's base rate (BR) is adjusted after one month....
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Class%20#10%20461%20IRR%20Flows0 - Interest Rate Risk (IRR)...

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