Class%20#11%20461%20IRR%20Values0

# Class%20#11%20461%20IRR%20Values0 - Interest Rate Risk:...

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Interest Rate Risk: Firm Value and the Duration Gap Model

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2 CE Presentations TODAY: Paul Mroz and Varun Karkhanis THURSDAY: Drew Osika and Angela Jiang Assignment: Text, Chapter 10 (pp. 266- 277) Assignment #1 due Thursday
3 Class Outline 1. Measuring firm value Book value vs. market value 1. Duration fundamentals Features of duration 1. Duration and interest rate risk For an asset For a portfolio of assets For a balance sheet 1. Duration gap 2. Assumptions and problems with DGap Convexity correction

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4 4 1. Measuring firm value When interest rates change, interest flows change (evolve) over time . We measure this exposure over the next year for a bank using its WATM Gap. Another dimension of interest rate risk, the impact of changes in interest rates on prices or values of assets and liabilities , and thus on firm value, occurs immediately . How will the value of the bank be affected by a change in interest rates? The focus is on firm value. But what value ?
5 5 Book value What is book value? How do we calculate it?

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6 6 Market value What is market value? How do we calculate it?
7 7 Market value (1) Market value of the outstanding stock —price per share times number of shares. This MV is also called going concern value or charter value ; it can not be negative (2) Market value of the assets minus market value of the liabilities —market value of the balance sheet . This MV is called liquidation value ; it can be negative The two values are related (correlated)

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8 We will use the second concept of market value—liquidation value —as we think about the impact of changes in interest rates on value, because interest rate changes cause direct and immediate changes in the market value of a bank’s assets and liabilities. Our key question is how much and in what direction will a bank’s value change when interest rates change ? Can we develop a measure (like a gap measure) of this risk exposure? YES. We will do so using
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## This note was uploaded on 10/28/2011 for the course FIN 461 taught by Professor Morgan during the Fall '11 term at University of Illinois at Urbana–Champaign.

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Class%20#11%20461%20IRR%20Values0 - Interest Rate Risk:...

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