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Unformatted text preview: Chapter 07 - Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques CHAPTER 7 RISK MANAGEMENT FOR CHANGING INTEREST RATES: ASSET-LIABILITY MANAGEMENT AND DURATION TECHNIQUES Goals of This Chapter : The purpose of this chapter is to explore the options bankers have today for dealing with risk especially the risk of loss due to changing interest rates and to see how a banks management can coordinate the management of its assets with the management of its liabilities in order to achieve the institutions goals. Key Topic In This Chapter Asset, Liability, and Funds Management Market Rates and Interest Rate Risk The Goals of Interest Rate Hedging Interest-Sensitive Gap Management Duration Gap Management Limitations of Interest Rate Risk Management Techniques Chapter Outline I. Introduction: The Necessity for Coordinating Bank Asset and Liability Management Decisions II. Asset-Liability Management Strategies A. Asset Management Strategy B. Liability Management Strategy C. Funds Management Strategy III. Interest Rate Risk: One of the Greatest Management Challenges A. Forces Determining Interest Rates B. The Measurement of Interest Rates 1. Yield to Maturity 2. Bank Discount Rate C. The Components of Interest Rates 1. Risk Premiums 2. Yield Curves 3. The Maturity Gap and the Yield Curve D. Responses to Interest Rate Risk 7-1 Chapter 07 - Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques IV. One of the Goals of Interest-Rate Hedging: Protect the Net Interest Margin A. The Net Interest Margin B. Interest-Sensitive Gap Management as a Risk- Management Tool 1. Asset-Sensitive Position 2. Liability-Sensitive Position 3. Dollar Interest-Sensitive Gap 4. Relative Interest Sensitive Gap 5. Interest Sensitivity Ratio 6. Computer-Based Techniques 7. Cumulative Gap 8. Strategies in Gap Management C. Problems with Interest-Sensitive GAP Management V. The Concept of Duration as a Risk-Management Tool A. Definition of Duration B. Calculation of Duration C. Net Worth and Duration D. Price Sensitivity to Changes in Interest Rates and Duration E. Convexity and Duration VI. Using Duration to Hedge Against Interest Rate Risk A. Duration Gap 1. Dollar Weighted Duration of Assets 2. Dollar Weighted Duration of Liabilities 3. Positive Duration Gap 4. Negative Duration Gap B. Change in the Banks Net Worth VII The Limitations of Duration Gap Management VIII. Summary of the Chapter Concept Checks 7-1. What do the following terms mean: Asset management? Liability management? Funds management? Asset management refers to a banking strategy where management has control over the allocation of bank assets but believes the bank's sources of funds (principally deposits) are outside its control. The key decision area for management was not deposits and other borrowings but assets....
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