Unit 27:-Interest Rate Risk Management

October 17, 2016

| No Comments
 Interest rate risk is the exposure of a bank’s financial condition to adverse movements in
interest rates.
 Gap: The gap is the difference between the amount of assets and liabilities on which the
interest rates are reset during a given period.
 Interest rate risk refers to volatility in Net Interest Income (NiI) or in variations in Net
Interest Margin (NIM)
 The degree of basis risk is fairly high in respect of banks that create composite assets out
of composite liabilities.
 The risk that the interest rate of different assets and liabilities may change in different
magnitudes is called basis risk.
 When assets and liabilities fall due to repricing in different periods, they can create a
mismatch. Such a mismatch or gap may lead to gain or loss depending upon how interest
rate in the market tend to move.
 The degree of basis risk is fairly high in respect of banks that create composite assets out
of composite liabilities
 When the variation in market interest rate causes the Nil to expand, the banks have
experienced a favourable basis shift and if the interest rate movement causes the Nil to
contract, the basis has moved against the bank.
 An yield curve is a line on a graph plotting the yield of all maturities of a particular
instrument
 Price risk occurs when assets are sold before their maturity dates.
 The price risk is closely associated with the trading book which is created for making
profit out of short-term movements in interest rates.
 Uncertainty with regard to interest rate at which the future cash flows can be reinvested is
called reinvestment risk.
 When the interest rate goes up, the bonds price decreases
 When the interest rate declines the bond price increases resulting in a capital gain but the
realised compound yield decreases because of lower coupon reinvestment income.
 Duration is a measure of the percentage change in the economic value of a position that
will occur, given a small change in the level of interest rates.
 Higher duration implies that a given change in the level of interest rates will have a larger
impact on economic value.
 Interest Rate Sensitive Gap: Interest Rate Sensitive Assets(RSA) – Interest Rate
Sensitive Liabilities (RSL).
 Positive Gap or Asset Sensitive Gap – RSA – RSL > 0 & Negative Gap or Liability
Sensitive – RSA – RSL < 0