Professional Documents
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Class 19
Class 19
two goals of maintaining profit levels and stabilising the balance sheet.
ALM stabilises the two elements by hedging against interest rate fluctuations.
a resource
L & OE:
Fixing a floating rate entails fixing the interest rate with another rate, such as LIBOR (London
Interbank Offer Rate). For instance, the floating-rate Ashugonj Bond is linked to government
securities.
Interest Income
Interest-related costs
Profitability may alter as a result of changes in interest-sensitive assets and liabilities. GAP is
the difference between interest-sensitive assets and liabilities. Profit fluctuation is equal to GAP
times fluctuation. Both assets and liabilities will experience the same change in interest rate. We
can mitigate the risk by lowering the GAP, and any changes in interest rates will result in a
stabilising of earnings. Greater interest rate hedging occurs at lower GAPs. The bank will be
shielded from interest rate changes in this way.
Changes in interest rates might also result in speculative gains for banks. Depending on the
bank's policies. Due to extensive exposure, speculative profit carries significant risk.
How is balance sheet stability guaranteed - DURATION:
The severity of the shock and the change's time horizon determine the degree to which a
change in interest rates impacts the price of a bond.
Both the interest-sensitive asset and the interest-sensitive liabilities need to be considered
throughout time. If the interest-sensitive asset's maturity is five years and the interest-sensitive
liability's is also five years
In three years, an increase in interest rates will result in a greater decline in asset value than in
obligation. Owner equity will thus decline.
For instance, the asset's change in value equals 10 * (.05 / 1.10), or 45%.
The DURATION analysis compares the duration of the interest-sensitive asset with the interest-
sensitive debt. When performing a DURATION analysis:
Step 4: Determine the average lifespan of assets using the weighted average of the assets.
A – L = OE
To obtain a target duration, the asset's or liability's duration will need to be modified.
Loan Amount:
When determining the loan rate, take into account the cost, the competition, and the target
market.
Total pricing zone is defined as the range between discount and parity pricing. Below discount
pricing, we will profit long-term (cost is taken into account); above premium pricing, we will lose
sales long-term (customer is taken into account); premium pricing must offer some additional
benefits.
Bank products are uniform, so premium pricing is not an option. In a same manner, I must
decrease my expenses in order to enlarge the zone. The interest rate for banks depends on:
1. There are two different sorts of costs: operating costs and fund costs
3. Profitability
Interest Rate of Loan = Funding Cost + Operating Cost + Profit Margin + Risk Premium
Base Rate, Prime Rate, Prime Lending Rate, plus Risk Premium, is the interest rate on a loan.
Profit Margin = Expected Return to Investors * Total Equity / Average Loans and Advances
We won't accept reduced or bought-in bills for loans or advances. An alternative is to multiply a
weight.
Typically, the base rate will be the same for all banks.
The base rate is fixed in foreign nations, and the rate is afterwards adjusted for varying credit
ratings using the risk premium.
Since there is no credit risk in Bangladesh, a portfolio technique is utilised to modify bad debt
using the risk premium.