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Asset Liabilities ALM
Asset Liabilities ALM
Chapter Contents
ALMs purpose How interest rate risk impact banks income? Interest rate risk: GAP and using GAP to measure interest rate risk to banks income Using Duration for ALM
Asset-Liability Management
Whats ALM?
Example
Suppose, a 100$ security is now sold on the market at price of $96 with days to maturity of 90 days. Whats DR, the YTM equivalent yield?
Example
DR = (100 96)/100 * 360/90 = 0.16 Equivalent YTM = (100 96)/96 *365/90 = 0.1690 Actual YTM =
When Interest Rates Rise, the Market Value of the Bond or Asset Falls When Interest Rates Fall, the Coupon Payments on the Bond are Reinvested at Lower Rates
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Reinvestment Risk
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.
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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.
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Net interest income or The market value of stockholders' equity A static measure of risk that is commonly associated with net interest income (margin) targeting Earnings sensitivity analysis extends GAP analysis by focusing on changes in bank earnings due to changes in interest rates and balance sheet composition
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GAP Analysis
Rate sensitive Asset/Liabilities (RSAs vs RSLs) and Non rate sensitive (NRS)
RSAs/ RSLs are assets or liabilities whose interest return or cost vary with interest rate movements over the same time horizon. E.g; short term securities.
RSAt
Rate Sensitive Assets
Those assets that will mature or reprice in a given time period (t)
RSLt
Rate Sensitive Liabilities
Those liabilities that will mature or reprice in a given time period (t)
Non rate sensitive (NRS) are assets or liabilities whose interest return or cost vary with interest rate movements over the same time horizon. E.g; Vault cash
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Example on RSAs/RSLs
Assets 1. Short term consumer loans (1 year maturity) 2. Long term consumer loans (2 year maturity) 3.Three-month Treasury Bills 4. Six-month Treasury Notes 5. Three year Treasury Bonds 6. 10 year, fixed rate mortgages 7. 30 year, floating rate mortgages (rate adjusted every nine months) Liabilities 50 Equity Capital (Fixed) 25 Demand deposits 30 Passbook savings 35 Three month CDs Three month Banker 70 acceptances 20 Six month CP One year time deposits 40 Two year time deposits 270 40 270 20 40 30 40 20 60 20
16 Within 1 year, Determine the RSAs =? RSLs = ? Hows about NRS for assets and liabilities?
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Example
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%.
4 year Car Loan 1 Year CD 8.50% 4.50% 4.00%
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Example
Traditional Static GAP Analysis
The banks one year funding GAP is -10,000 If interest rates rise (fall) in 1 year, the banks margin will fall (rise)
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Example
Consider the following balance sheet:
Expected Balance Sheet for Hypothetical Bank Assets Yield Liabilities Cost Rate sensitive $ 500 8.0% $ 600 4.0% Fixed rate $ 350 11.0% $ 220 6.0% Non earning $ 150 $ 100 $ 920 Equity $ 80 Total $ 1,000 $ 1,000 NII = (0.08 x 500 + 0.11 x 350) - (0.04 x 600 + 0.06 x 220) NII = 78.5 - 37.2 = 41.3 NIM = 41.3 / 850 = 4.86% GAP = 500 - 600 = -100
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Total
$ 2,000
NII = (0.08 x 1000 + 0.11 x 700) - (0.04 x 1200 + 0.06 x 440) NII = 157 - 74.4 = 82.6 NII and GAP double, but NIM = 82.6 / 1700 = 4.86% GAP = 1000 - 1200 = -200 stays the same.
NIM
RSAs increase to $540 while fixed-rate assets decrease to $310 and RSLs decrease to $560 while fixed-rate liabilities increase to $260
Expected Balance Sheet for Hypothetical Bank Assets Yield Liabilities Cost Rate sensitive $ 540 8.0% $ 560 4.0% Fixed rate $ 310 11.0% $ 260 6.0% Non earning $ 150 $ 100 $ 920 Equity $ 80 Total $ 1,000 $ 1,000 NII = (0.08 x 540 + 0.11 x 310) NII = 77.3 - 38 = 39.3 NIM = 39.3 / 850 = 4.62% GAP = 540 - 560 = -20 - (0.04 x 560 + 0.06 x 260)
Although the banks GAP (and hence risk) is lower, 30 NII is also lower.
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Q: Determining the GAP? Net interest income? Net interest margin? How much will net interest income change if interest rates fall by 2%? What changes in portfolio composition would you recommend to management if you expected interest rates to increase?
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A loan with annual interest payment @10% for 5 years, the loan principal is $1000. What is the Duration of the loan if the current market price is $1000? How is the loan price vary if the interest rates increase by 1%?
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NW ! A L
(NW ! (A (L
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Duration GAP
Duration GAP = Duration of asset portfolio Duration of bank liabilities The bank tries to manage duration gap approaching zero Positive duration gap Negative duration gap
Durationofeachassetxmarketvalue
AssetportfolioDuration !
i !1
Totalmarketvalueofallassets
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