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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

repricing gap example
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
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
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
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 example1
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
Unequal Rate Change Example
  • Spread effect 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 example1
Unequal Rate Change Example

Spread effect 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 example2
Unequal Rate Change Example

Spread effect 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
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 items1
Difficult Balance Sheet Items
  • Prime-based loans
  • Adjustable rate mortgages
    • 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
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 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.
a word about spreads
A Word About Spreads
  • 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
*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*
  • 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
*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
*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
*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
Modified Maturity Model

Correct for leverage

to immunize, change:

MA - ML = 0 to

MA – ML& E = 0 with ME = 0

(not in text)

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