# Part B Covers pages 201-205 - PowerPoint PPT Presentation

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Part B Covers pages 201-205. Repricing Gap Example. Assets Liabilities Gap Cum. Gap 1-day \$ 20 \$ 30 \$-10 \$-10 >1day-3mos. 30 40 -10 -20 >3mos.-6mos. 70 85 -15 -35

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Part B Covers pages 201-205

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Part B

Covers pages 201-205

### Repricing Gap Example

AssetsLiabilitiesGapCum. Gap

1-day \$ 20 \$ 30 \$-10 \$-10

>1day-3mos. 30 40 -10 -20

>3mos.-6mos. 70 85 -15 -35

>6mos.-12mos. 90 70 +20 -15

>1yr.-5yrs. 40 30 +10 -5

>5 years 10 5 +5 0

### Applying the Repricing Model

• Example II:

If we consider the cumulative 1-year gap,

DNII = (CGAPone year) DR = (-\$15 million)(.01)

= -\$150,000.

### Equal Rate Changes on RSAs, RSLs

• Example: Suppose rates rise 1% for RSAs and RSLs. Expected annual change in NII,

NII = CGAP ×  R

= -\$15 million × .01

= -\$150,000

• With positive CGAP, rates and NII move in the same direction.

• Change proportional to CGAP

### Unequal Changes in Rates

• If changes in rates on RSAs and RSLs are not equal, the spread changes. In this case,

NII = (RSA ×  RRSA ) - (RSL ×  RRSL )

### Repricing Gap Example

AssetsLiabilitiesGapCum. Gap

1-day \$ 20 \$ 30 \$-10 \$-10

>1day-3mos. 30 40 -10 -20

>3mos.-6mos. 70 85 -15 -35

>6mos.-12mos. 90 70 +20 -15

210225

>1yr.-5yrs. 40 30 +10 -5

>5 years 10 5 +5 0

### Unequal Rate Change Example

RSA rate rises by 1.0% and RSL rate rises by 1.0%

NII =  interest revenue -  interest expense

= (\$210 million × 1.0%) - (\$225 million × 1.0%)

= \$2,100,000 -\$2,250,000 = -\$150,000

### Unequal Rate Change Example

RSA rate rises by 1.2% and RSL rate rises by 1.0%

NII =  interest revenue -  interest expense

= (\$210 million × 1.2%) - (\$225 million × 1.0%)

= \$2,520,000 -\$2,250,000 = \$270,000

### Unequal Rate Change Example

RSA rate rises by 1.0% and RSL rate rises by 1.2%

NII =  interest revenue -  interest expense

= (\$210 million × 1.0%) - (\$225 million × 1.2%)

= \$2,100,000 -\$2,700,000 = -\$600,000

### Difficult Balance Sheet Items

• Equity/Common Stock O/S

• Ignore for repricing model, duration/maturity = 0

• Demand Deposits

• Treat as 30% repricing over 5 years/duration = 5 years 70% repricing immediately/duration = 0

• Passbook Accounts

• Treat as 20% repricing over 5 years/duration = 5 years 80% repricing immediately/duration = 0

• Amortizing Loans

• We will bucket at final maturity, but really should be spread out in buckets as principal is repaid. Not a problem for duration/market value methods

### Difficult Balance Sheet Items

• Prime-based loans

• Put in based on adjustment date

• Repricing/maturity/duration models cannot cope with life-time cap

• Assets with options

• Repricing model cannot cope

• Duration model does not account for option

• Only market value approaches have the capability to deal with options

• Mortgages are most important class

• Callable corporate bonds also

### Restructuring Assets & Liabilities

• The FI can restructure its assets and liabilities, on or off the balance sheet, to benefit from projected interest rate changes.

• Positive gap: increase in rates increases NII

• Negative gap: decrease in rates increases NII

• The “simple bank” we looked at does not appear to be subject to much interest rate risk.

• Let’s try restructuring for the “Simple S&L”

### Weaknesses of Repricing Model

• Weaknesses:

• Ignores market value effects and off-balance sheet (OBS) cash flows

• Overaggregative

• Distribution of assets & liabilities within individual buckets is not considered. Mismatches within buckets can be substantial.

• Ignores effects of runoffs

• Bank continuously originates and retires consumer and mortgage loans and demand deposits/passbook account balances can vary. Runoffs may be rate-sensitive.

• Text example: Prime-based loans versus CD rates

• What about libor-based loans versus CD rates?

• What about CMT-based loans versus CD rates

• What about each loan type above versus wholesale funding costs?

• This is why the industry spreads all items to Treasury or LIBOR

### *The Maturity Model

• Explicitly incorporates market value effects.

• For fixed-income assets and liabilities:

• Rise (fall) in interest rates leads to fall (rise) in market price.

• The longer the maturity, the greater the effect of interest rate changes on market price.

• Fall in value of longer-term securities increases at diminishing rate for given increase in interest rates.

### Maturity of Portfolio*

• Maturity of portfolio of assets (liabilities) equals weighted average of maturities of individual components of the portfolio.

• Principles stated on previous slide apply to portfolio as well as to individual assets or liabilities.

• Typically, maturity gap, MA - ML > 0 for most banks and thrifts.

### *Effects of Interest Rate Changes

• Size of the gap determines the size of interest rate change that would drive net worth to zero.

• Immunization and effect of setting

MA - ML = 0.

### *Maturities and Interest Rate Exposure

• If MA - ML = 0, is the FI immunized?

• Extreme example: Suppose liabilities consist of 1-year zero coupon bond with face value \$100. Assets consist of 1-year loan, which pays back \$99.99 shortly after origination, and 1¢ at the end of the year. Both have maturities of 1 year.

• Not immunized, although maturity gap equals zero.

• Reason: Differences in duration**

**(See Chapter 9)

### *Maturity Model

• Leverage also affects ability to eliminate interest rate risk using maturity model

• Example:

Assets: \$100 million in one-year 10-percent bonds, funded with \$90 million in one-year 10-percent deposits (and equity)

Maturity gap is zero but exposure to interest rate risk is not zero.

### Modified Maturity Model

Correct for leverage

to immunize, change:

MA - ML = 0 to

MA – ML& E = 0 with ME = 0

(not in text)