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Social Science
Economics
Monetary Economics
commercial bank mgt fin 4610 ch, 7,8,9
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Terms in this set (87)
IRR means
interest rate risk
volatile interest rate =
they change a lot
when where interest rates very volatile ?
1970s and 2000s
IRR =
the change in interest rates lead to change in net interest income(NII)
is it possible for NII to change in interest rate?
yes because NII can be changed by volume, rate, and mix
change in mix:
someone has 5 year CD and matures today rate = 4% . We have been paying 4%. They want to take money from CD and put into mda account , rate is only 1%, so wet from 4% to 1%.
net interest income =
interest income - interest expense
interest rates change doesn't effect
fixed rate loans and CDS
GAP =
rate sensitive assets - rate sensitive liabilities
Rate Sensitive Assets
assets that are effected by rate change in a set time frame.
-variable rate securities
-short-term securities
-t-bills,CDs that are 6 months or less
rate sensitive asset - loans
loans that are tied to a prime rate through an index
-commercial loans
-mortgages
-adjustable-rate mortgages(if adjusted w/in time frame)
-any principle repayments
Rate Sensitive Liabilities (RSL)
-checking accts + now accounts that bear interest and rate changes w/in time frame.
-time deposits (CDS that expire in time fram)
if we have positive GAP and rates increase...
NII increases
positive gap means that ...
we are asset sensitive and have more rate sensitive assets than rate sensitive liabilities
if we have positive GAP and rates decrease...
NII decreases
if we have negative GAP and rates increase...
NII decreases
if we have negative GAP and rates decrease...
NII increases
to create positive GAP...
increase RSA and lower RSL
to increase RSA...
decrease fixed assets and move to RSA b/b they earn lower rate
to lower RSL...
increase Fixed rate liabilities and lower RSL.
if try to make a change in GAP and rates dont change...
NII goes down
if we have a positive GAP that we want to reduce we are afraid...
that interest rates are going to go down
if interest rates go down...
more dollar amount of assets are going to be repriced downward than liabilities.
if afraid interest rates go down the bank needs to invest in ....
assets that are longer term adn able to be repriced keeping in mind that prices change to
if afraid interest rates go down the banks need to make more....
make more fixed rate loans so they can keepp the rate high
-going to have to negotiate w/ customer on price
if afraid interest rate go up banks want customers to take _____ rate loans?
variable
if afraid interest rates are going to go down, banks want liability customers to take ______ term loans
short-term
AND take MDA and NOW accounts so and reprice rates down.
Dynamic GAP analysis
When interest rates change the $ amount of RSA and RSL will change purely because interest rate change
•Embedded options:
options that bank gives or sells to customers that can be exercised when they want when in the money
- callable bonds
- things that can be repriced
if interest rates fall, bonds may be
called away and the issuing company will resell at new higher price
if rated drop , mortgage holders will...
refinance
liability embedded options...
are exercised when rates go up
if rates rise, CD buyers...
want to renew with another CD and the new higher rate
if rates rise, customers that have large amounts of money in non-interest bearing accounts will..
start to transfer thier money to interest bearing acounts
if rates rise, the maturity structure...
gets shorter
customers want ____ liabilities in a rising rate environment
shorter
if rates rise we become more ______ sensitive
liability
1% = ____ basis points
100
when interest rates change _______ change first
rates on assets change first because loans often tied to prime rate through index and the prime rate changes immediately
MVE is also known as
economic value of equity
MVE is really important to regulators and....
when MVE starts to go down, regulators get concerned because you cant cover losses if MVE drops to far
if we have a positive GAP and rates increase, MVE _____
decreases
if we have a positive GAP and rates decrease, MVE _____
increases
if we have a negative GAP and rates increase, MVE _____
increases
if we have a negative GAP and rates decrease, MVE _____
decreases
when interest rate rise , the value of assets and liabilities will ____
fall
when interest rates fall, the value of assets and liabilities will _____
rise
total value of assets - total value of liabilities =
equity
if interest rates increase and the MV of assets decrease more than the MV of liabilities....
equity will decline
=dont want this to happen
if interest rates go down and the MV of liabilities go up more that the MV of assets....
equity will decline
if the MV of assets increase more the the MV of liabilities....
equity increases
weighted average of duration of assets (DA) =
= (each asset/ total assets) * duration of that asset
Duration of an asset =
[sum of PV of CFs] / MV of the asset
Weighted avg of duration of liabilities =
(each liability / total liabilities) * duration of that asset
Expected economic net interest income =
($amount of each asset
rate you earn on it) - ($amount of each liability
rate you earn on it )
DGAP =
DA - (DL) * (TL / TA)
if we have a positive DGAP, duration of assets are
greater than the duration of liabilities
positive DGAP + interest rates increase
assets decrease more than liabilities and get a decrease in equity.
positive DGAP + interest rates decrease
assets increase more then liabilities and get and increase in equity
negative DGAP + interest rates increase
liabilities decrease more than assets and get an increase in equity
negative DGAP + interest rates decrease
liabilities increase more than assets and get a decrease in equity
if we have a DGAP = 0 , a interest rate change causes...
nothing to happen to equity
chg price =
-D
(chg. In interest rate) / (1+y)
MV of asset
y =
initial market rateq
Chg MV assets =
the change of Mv of each asset added together
Chg MV liabilities =
the change of MV for each liability
Chg. MV equity =
chg MV assets - chg MV liabilities.
immunize means
make DGAP = 0
to immunize if you have a positive DGAP to begin with.....
leave assets (DA) alone and increase DL
to increase DL ....
drive off shorter term liabilities and increase longer term liabilities
Would it be a good strategy to run off 1yr time deposits and issue 6 yr coupon cd in order to increase DL and immunized portfolio
true
∆ EVE (change in MVE) =
-DGAP[∆i/(1+y)]MVA
Where y =
weighted average rate of return on interest bearing assets
Where ∆i =
Change in interest rate
duration work well when there is a ________ change in interest rates
small
Swaps :
is a contract we enter into w/ some other entity where one of us receives variable or fixed rate of interest on certain amount of money and other pays the rate on the same amount of money
Notional amount of money =
the dollar amount of the swap
when are swaps settled ?
each quarter
swaps are not _________
standardized
swaps work best w/ ....
banks fins someone w/ opposite interest rate risk than us
if we have a negative GAP and afraid interest rates are going to increase. and NII go down, what kinds of swap do we want?
we want a to receive a variable rate and pay a fixed rate.
= variable rate swap
take a long position on futures if you expect the price of underlying to ...
rise
take a short position on futures if you expect price on underlying to...
fall
a liability hedge is to
ta a short position on futures
•Negative gap, afraid interest rates go up, and cost of liabilities increasing, so short on futures
•An asset hedge taking a short position on futures....
•Have securities in investment portfolio, if interest rates go down, value go up
•In 6 months, you sell all of it, to fund loan to someone.
•Afraid interest rates go up, b/c come time to sell you securities won't be worth as much
•An asset hedge taking a long position on futures...
•expecting large sum or money in the future
•Afraid of interest rates going down before we get the money
•If rates down price go up
•Buy the futures contract and make money that way.
Earnings sensitivity analysis differs from static GAP analysis by:
looking at a wide range of interest rate environments
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