Bank Financial Mgt Week 3 Lecture Slides - Full Size

Bank Financial Mgt Week 3 Lecture Slides - Full Size -...

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BUSINESS SCHOOL FINC3018 BANK FINANCIAL MANAGEMENT Week 3
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This Week’s Objectives Build on the models examined last week and To examine the application of - Duration; - Modified Duration; - Duration Gap; - Present Value of a Basis Point (PVBP) and to the measurement and management of interest rate risk arising from the maturity mismatch in bank balance sheets.
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Recap from Last Week Last week we examined how we could assess the amount of interest rate risk that exists in portfolios of interest rate sensitive assets - The significance of changes in the value of a fixed income security as a measure of interest rate risk was identified We examined: - Repricing model - Changes in earnings - Maturity model - Weighted the maturity for the current value of the stock - Both were seen to have shortcomings
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Duration Duration is seen as an enhanced model Duration is the Present value weighted average maturity of a security - Rather than being the product of present value and maturity (Maturity Model) it incorporates the value of the coupon flows (cashflows) It can also be applied to a portfolio - This is the level at which we identified we really need to measure and manage risk The dimension of duration is time & thus makes it useful in measuring the impact on price from uniform shifts in yields - We identified the significance of time to maturity in assessing the impact of interest risk - It is important to note that Duration assumes and relies on uniform changes in yields across the yield curve
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Duration - graphically The present value weighted average time to maturity of the cash flows of a security Year 7 Year 6 Year 5 Year 4 Year 3 Year 2 Year 1 Duration 0 Principal Repayment Coupon Payment
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Calculating Duration Eg 2 year Semi-annual Bond 10.00% coupon @ Par Term n Cashflow Discounted PV Term x PV Years 0.5 1.0 5 4.7619 2.3810 1.0 2.0 5 4.5351 4.5351 1.5 3.0 5 4.3192 6.4788 2.0 4.0 105.0 86.3838 172.7675 100.0000 186.1624 Duration is : 186.1624 1.8616 years 100.0000 Modified Duration 1.77%
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Macauley’s Duration ( D ) D C r t t t t n t t t n C r = + × = = + ( ) ( ) 1 1 1 1 Where: C t = Cashflow at time t r = the periodic interest rate or current yield n = the number of periods
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Duration and Price (Value) Change Duration represents the value weighted term of the security A small change in yield will result in a change in price (as a proportion) as follows: eg in the previous example where D=1.8616 and the price was 100, a small change in yield (0.01%) would change price by
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Bank Financial Mgt Week 3 Lecture Slides - Full Size -...

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