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Interest Rate Risk Management Tools

The document discusses risk management strategies for changing interest rates, focusing on interest rate risk and its impact on floating and fixed rate assets. It introduces methods such as the Interest Sensitive Gap Method and Duration Gap Method to assess and manage risks associated with interest rate fluctuations. Additionally, it highlights the limitations of these methods and the importance of asset-liability management strategies to control interest rate risk within acceptable levels.

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madanlal
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24 views3 pages

Interest Rate Risk Management Tools

The document discusses risk management strategies for changing interest rates, focusing on interest rate risk and its impact on floating and fixed rate assets. It introduces methods such as the Interest Sensitive Gap Method and Duration Gap Method to assess and manage risks associated with interest rate fluctuations. Additionally, it highlights the limitations of these methods and the importance of asset-liability management strategies to control interest rate risk within acceptable levels.

Uploaded by

madanlal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

RISK MANAGEMENT FOR CHANGING INTEREST RATES

Interest rate risk Risk of loss on A/C of change in int. rates

Floating Rate Assets → Reinvestment Risk

(Risk of Income on Asset , Cost of liability )

INTEREST SENSITIVE GAP METHOD

𝑰𝑺𝑨
𝑰𝑺 𝑮𝒂𝒑 = 𝑰𝑺𝑨 − 𝑰𝑺𝑳 𝑰𝑺 𝑹𝒂𝒕𝒊𝒐 =
𝑰𝑺𝑳
𝑰𝑺 𝑮𝒂𝒑
𝑹𝒆𝒍𝒂𝒕𝒊𝒗𝒆 𝑰𝑺 𝑮𝒂𝒑 = ∆ 𝑵𝑰𝑰 = 𝑰𝑺 𝑮𝒂𝒑 × ∆ 𝒓𝒂𝒕𝒆
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔

𝑷𝒓𝒐𝒃𝒍𝒆𝒎 = ∗ ∆ 𝒓𝒂𝒕𝒆 𝒂𝒔𝒔𝒆𝒕 ≠ 𝒓𝒂𝒕𝒆 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒚


∗ 𝒑𝒂𝒔𝒔𝒊𝒏𝒈 𝒐𝒗𝒆𝒓 𝒔𝒑𝒆𝒆𝒅 𝒐𝒇 𝒂𝒔𝒔𝒆𝒕𝒔 > 𝒔𝒑𝒆𝒆𝒅 𝒐𝒇 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒚

Earning Impact
Rate ↑ Rate ↓
Improvement = Weighted IS Gap
RSA > RSL Profit #Loss
Limitations of IS Gap Method
RSA < RSL *Loss Profit

Immunizing earning Impact


Ignores impact on Net worth (Price impact
ignored)

# Decrease ISA
Difficult to bucket asset/liability Increase ISL
Extend Asset Maturity
Repricing time difficult to identify (Behaviour Shorten liability Maturity
Analysis)
* Increase ISA
Decrease ISL
Not including off - b/s items.
Extend liability Maturity
Shorten Asset Maturity

W W W . P E A K S 2 T A I L S . C O M
Fixed Rate Assets → Price Risk Value Impact

(Risk of Asset Value , Liability value ) Rate ↑ Rate ↓


RSA > RSL Loss Profit

DURATION GAP METHOD RSA < RSL Profit Loss

𝑫𝑨 ×𝑨−𝑫𝑳 ×𝑳
𝑫𝒆𝒒 =
𝒆𝒒.

𝑫𝒆𝒒
𝑴𝒐𝒅𝒊𝒇𝒊𝒆𝒅 𝑫𝒆𝒒 =
𝟏+𝒓

∆ 𝒊𝒏 𝒏𝒆𝒕 𝒘𝒐𝒓𝒕𝒉 𝒐𝒓 ∆ 𝒊𝒏 𝒆𝒒. 𝒗𝒂𝒍𝒖𝒆 = 𝑴𝒐𝒅𝒊𝒇𝒊𝒆𝒅 𝑫𝒆𝒒 × ∆ 𝒊𝒏 𝒓𝒂𝒕𝒆 × 𝒆𝒒.

Immunizing Price Risk / Value impact

𝑳
𝐷𝐴 = 𝑫𝑳 × 𝑨 LEVERAGE ADJUSTED ∆ in Net Worth or
DURATION GAP rates eq. value
𝐷𝐴 𝑳 {Leverage Adjusted Rates ↑ Decrease
= Positive
𝑫𝑳 𝑨 Duration Gap} 𝑳
𝑫𝑨 > 𝑫𝑳 × Rates ↓ Increase
𝑨

𝑷𝒓𝒐𝒃𝒍𝒆𝒎 = Negative Rates ↑ Increase


∆ 𝒓𝒂𝒕𝒆 𝒂𝒔𝒔𝒆𝒕 ≠ ∆ 𝒓𝒂𝒕𝒆 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒚 𝑳
𝑫𝑨 < 𝑫𝑳 × Rates ↓ Decrease
𝑨

Improvement:- Incorporate Sensitivities (Weights)

Limitations of Duration Gap Method

To immunize, locating precise asset/liability is costly

Immunization Dynamic (Rate Changes Duration Changes)

Difficult to find out embedded option duration (ex:- pre - payment)

Immunize only for small II shift (convexity not considered)

W W W . P E A K S 2 T A I L S . C O M
Asset - Liability
Management
Strategies

Asset Management Liability Management Funds Management


Strategy Strategy Strategy

Funding through
liabilities is
Entire B/S is an
exogenously
Banks Can control optimization exercise.
determined or
funding (deposit or So, Manage both
strongly regulated. So,
non deposit) by using asset & liabilities &
Banks cannot control
control lever (OFFER control interest rate
liability but Can
RATE) risk within tolerance
control assets (whom
level.
to lend & at what
terms)

W W W . P E A K S 2 T A I L S . C O M

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