Chapter%209_Interest%20Rate%20Risk%20II

Chapter%209_Interest%20Rate%20Risk%20II - . (Chapter 9)...

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1 Prepared by Patty Robertson May not be used without permission Chapter 9 Interest Rate Risk II
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Interest Rate Risk – Part II 2 In the second chapter on interest rate risk, we look at: The difference between book value and market value. The principles of bond valuation as a tool to understand what affects market value. The concept of duration and how duration modeling is a more comprehensive approach to measure and manage interest rate risk.
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Book Value vs. Market Value 3 U.S. corporations, including FIs, record the value of assets/liabilities on the balance sheet based on GAAP. Assets are recorded based on book (historical) value or the value at the time of acquisition. Based on market conditions, the economic value of assets could be very different. FI investment assets that are expected to be held through maturity are recorded at book value
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Unformatted text preview: . (Chapter 9) Assets held for trading ARE reported based on market value through a process called marking-to-market. (Chapter 10) Basics of Bond Valuation - Review 4 To understand how book value can significantly differ from market value, we review the inverse relationship between bond prices and interest rates. Bonds will act as a surrogate for loans on the FIs books. The price of a bond is based on the principles of the time value of money. 5 Bond market values (prices) reflect the present value of all promised cash flows discounted at the required rate of return. Cash flows include: Interest (or coupon) payments. Lump-sum payment when the bond matures. Basics of Bond Valuation - Review r) (1 F C ...... r) (1 C r) (1 C r) (1 C P t 3 2 1 + + + + + + + + + =...
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Chapter%209_Interest%20Rate%20Risk%20II - . (Chapter 9)...

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