asset-liability management 1
DESCRIPTION
TRANSCRIPT
- 1. Asset-Liability Management
- The Purpose of Asset-Liability Management is to Control a Banks Sensitivity to Changes in Market Interest Rates and Limit its Losses in its Net Income or Equity
- 2. Yield to Maturity (YTM)
- 3. Bank Discount Rate (DR) Where: FV equals Face Value
- 4. Conversion of DR into YTM
- YTM equivalent yield =
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- (100 purchase price)/Purchase Price * (365/days to maturity)
- Note that the DR ant the conversion to YTM equivalent yields are approximations that are popular with banks.
- 5. Example
- Suppose that we purchase a money market security for $96. The security will mature in 90 days and its face value is $100.
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- What is the DR, the YTM equivalent yield, and the actual YTM?
- 6. Example
- DR = (100 96)/100 * 360/90 = 0.16
- Equivalent YTM = (100 96)/96 *365/90 = 0.1690
- Actual YTM =
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- PV = -96, FV = 100, N = 90/365, I = ?
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- I = 18%
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- 7. Interest Rate Risk : GAP & Earnings Sensitivity
- When a banks assets and liabilities do not reprice at the same time, the result is a change in net interest income.
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- The change in the value of assets and the change in the value of liabilities will also differ, causing a change in the value of stockholders equity
- 8. Interest Rate Risk
- Banks typically focus on either:
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- Net interest income or
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- The market value of stockholders' equity
- GAP Analysis
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- A static measure of risk that is commonly associated with net interest income (margin) targeting
- Earnings Sensitivity Analysis
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- Earnings sensitivity analysis extends GAP analysis by focusing on changes in bank earnings due to changes in interest rates and balance sheet composition
- 9. Interest Rate Risk
- Price Risk
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- When Interest Rates Rise, the Market Value of the Bond or Asset Falls
- Reinvestment Risk
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- When Interest Rates Fall, the Coupon Payments on the Bond are Reinvested at Lower Rates
- 10. Interest Rate Risk: Reinvestment Rate Risk
- If interest rates change, the bank will have to reinvest the cash flows from assets or refinance rolled-over liabilities at a different interest rate in the future.
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- An increase in rates, ceteris paribus, increases a banks interest income but also increases the banks interest expense.
- Static GAP Analysis considers the impact of changing rates on the banks net interest income.
- 11. Interest Rate Risk: Price Risk
- If interest rates change, the market values of assets and liabilities also change.
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- The longer is duration, the larger is the change in value for a given change in interest rates.
- Duration GAP considers the impact of changing rates on the market value of equity.
- 12. Measuring Interest Rate Risk with GAP
- Traditional Static GAP Analysis GAP t = RSA t -RSL t
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- RSA t
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- Rate Sensitive Assets
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- Those assets that will mature or reprice in a given time period (t)
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- RSL t
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- Rate Sensitive Liabilities
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- Those liabilities that will mature or reprice in a given time period (t)
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- 13. What Determines Rate Sensitivity?
- An asset or liability is considered rate sensitivity if during the time interval:
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- It matures
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- It represents and interim, or partial, principal payment
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- It can be repriced
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- The interest rate applied to the outstanding principal changes contractually during the interval
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- The outstanding principal can be repriced when some base rate of index changes and management expects the base rate / index to change during the interval
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- 14. Interest-Sensitive Assets
- Short-Term Securities Issued by the Government and Private Borrowers
- Short-Term Loans Made by the Bank to Borrowing Customers
- Variable-Rate Loans Made by the Bank to Borrowing Customers
- 15. Interest-Sensitive Liabilities
- Borrowings from Money Markets
- Short-Term Savings Accounts
- Money-Market Deposits
- Variable-Rate Deposits
- 16. Example
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- A bank makes a $10,000 four-year car loan to a customer at fixed rate of 8.5%. The bank initially funds the car loan with a one-year $10,000 CD at a cost of 4.5%. The banks initial spread is 4%.
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- What is the banks one year gap?
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- 17. Example
- Traditional Static GAP Analysis
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- What is the banks 1-year GAP with the auto loan?
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- RSA 1yr = $0
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- RSL 1yr = $10,000
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- GAP 1yr = $0 - $10,000 = -$10,000
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- The banks one year funding GAP is -10,000
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- If interest rates rise (fall) in 1 year, the banks margin will fall (rise)
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- 18. Measuring Interest Rate Risk with GAP
- Traditional Static GAP Analysis
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- Funding GAP
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- Focuses on managing net interest income in the short-run
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- Assumes a parallel shift in the yield curve, or that all rates change at the same time, in the same direction and by the same amount.
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- 19. Other Gap Measurements Relative Interest-Sensitive Gap Interest Sensitivity Ratio
- 20. Asset-Sensitive Bank Has:
- Positive Dollar Interest-Sensitive Gap
- Positive Relative Interest-Sensitive Gap
- Interest Sensitivity Ratio Greater Than One
- 21. Liability Sensitive Bank Has:
- Negative Dollar Interest-Sensitive Gap
- Negative Relative Interest-Sensitive Gap
- Interest Sensitivity Ratio Less Than One
- 22. Net Interest Margin
- 23. Factors Affecting Net Interest Income
- Changes in the level of interest rates
- Changes in the composition of assets and liabilities
- Changes in the volume of earning assets and interest-bearing liabilities outstanding
- Changes in the relationship between the yields on earning assets and rates paid on interest-bearing liabilities
- 24. Example
- Consider the following balance sheet:
- 25. Examine the impact of the following changes
- A 1% increase in the level of all short-term rates?
- A 1% decrease in the spread between assets yields and interest costs such that the rate on RSAs increases to 8.5% and the rate on RSLs increase to 5.5%?
- Changes in the relationship between short-term asset yields and liability costs
- A proportionate doubling in size of the bank?
- 26. 1% increase in short-term rates With a negative GAP, more liabilities than assets reprice higher; hence NII and NIM fall
- 27. 1% decrease in the spread NII and NIM fall (rise) with a decrease (increase) in the spread. Why the larger change?
- 28. Changes in the Slope of the Yield Curve
- If liabilities are short-term and assets are long-term, the spread will
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- widen as the yield curve increases in slope
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- narrow when the yield curve decreases in slope and/or inverts
- 29. Proportionate doubling in size NII and GAP double, but NIM stays the same. What has happened to risk?
- 30. Changes in the Volume of Earning Assets and
Interest-Bearing Liabilities
- Net interest income varies directly with changes in the volume of earning assets and interest-bearing liabilities, regardless of the level of interest rates
- 31. RSAs increase to $540 while fixed-rate assets decrease to $310 and RSLs decrease to $560 while fixed-rate liabilities increase to $260 Although the banks GAP (and hence risk) is lower, NII is also lower.
- 32. Changes in Portfolio Composition and Risk
- To reduce risk, a bank with a negative GAP would try to increase RSAs (variable rate loans or shorter maturities on loans and investments) and decrease RSLs (issue relatively more longer-term CDs and fewer fed funds purchased)
- Changes in portfolio composition also raise or lower interest income and expense based on the type of change
- 33. Changes in Net Interest Income are directly proportional to
the size of the GAP
- If there is a parallel shift in the yield curve:
- It is rare, however, when the yield curve shifts parallel
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- If rates do not change by the same amount and at the same time, then net interest income may change by more or less.
- 34. Summary of GAP and the Change in NII