Ch 8 2012 - 1 Chapter 8 Interest Rate Risk I 2 Overview We...

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Chapter 8 Interest Rate Risk I 1
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Overview We will first review interest rate risks from Ch. 7. This chapter discusses the interest rate risk associated with financial intermediation: Federal Reserve monetary policy. Repricing model. Duration model will wait until Ch. 9. We will not discuss Appendices on term structure of interest rates and the maturity model. 2
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Interest Rate Risk Review Interest rate risk results from mismatching in maturities (actually, durations) of assets and liabilities. 3 Types of interest rate risk: Refinancing risk (refinance at a higher rate). Reinvestment risk (reinvest at a lower rate). Market value risk (loss of market value). 3 ways to hedge: Match maturities or durations. Have adjustable rates. Derivatives. 3
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Determination of Interest Rates Interest rates determined by demand & supply for loanable funds. We focus on the most important demander & supplier of funds - Central Bank (Federal Reserve). 4
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Federal Reserve Board: U.S. central bank. Open market operations influence money supply, inflation, and interest rates. Can buy or sell treasuries or engage in repurchase agreements. Actions of Fed in response to 2001 attacks on World Trade Center and the bursting of the dot com bubble. Lowered interest rates 11 times within the year. June 2004 - August 2006. Inflation concerns take prominence. 17 consecutive increases in interest rates, quarter of a point each. Some argue that the Fed did not raise rates soon enough or fast enough. 5
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Central Bank and Interest Rates Target is primarily short term rates. Focus on federal funds rate (short-term rates banks charge to each other in the Federal Funds market) in particular. Longer-term rates are primarily determined by expectation of future short-term interest rate plus term premiums. Longer-term rates may also be determined by “operation
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This note was uploaded on 02/17/2012 for the course FINA 465 taught by Professor Berger during the Spring '11 term at South Carolina.

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Ch 8 2012 - 1 Chapter 8 Interest Rate Risk I 2 Overview We...

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