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Asset-Liability Management: Determining and Measuring Interest Rates and Controlling Interest-Sensitive and Duration Ga

Asset-Liability Management: Determining and Measuring Interest Rates and Controlling Interest-Sensitive and Duration Gaps. Asset-Liability Management.

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Asset-Liability Management: Determining and Measuring Interest Rates and Controlling Interest-Sensitive and Duration Ga

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  1. Asset-Liability Management: Determining and Measuring Interest Rates and Controlling Interest-Sensitive and Duration Gaps
  2. Asset-Liability Management The Purpose of Asset-Liability Management is to Control a Bank’s Sensitivity to Changes in Market Interest Rates and Limit its Losses in its Net Income or Equity
  3. Historical View of Asset-Liability Management Asset Management Strategy Liability Management Strategy Funds Management Strategy
  4. Interest Rate Risk Price Risk When Interest Rates Rise, the Market Value of the Bond or Asset Falls Reinvestment Risk When Interest Rates Fall, the Coupon Payments on the Bond are Reinvested at Lower Rates
  5. Yield to Maturity (YTM)
  6. Bank Discount Rate (DR) Where: FV equals Face Value
  7. Market Interest Rates Function of: Risk-Free Real Rate of Interest Various Risk Premiums Default Risk Inflation Risk Liquidity Risk Call Risk Maturity Risk
  8. Yield Curves Graphical Picture of Relationship Between Yields and Maturities on Securities Generally Created With Treasury Securities to Keep Default Risk Constant Shape of the Yield Curve Upward – Long-Term Rates Higher than Short-Term Rates Downward – Short-Term Rates Higher than Long-Term Rates Horizontal – Short-Term and Long-Term Rates the Same
  9. Net Interest Margin
  10. Goal of Interest Rate Hedging One Important Goal of Interest Rate Hedging is to Insulate the Bank from the Damaging Effects of Fluctuating Interest Rates on Profits
  11. Interest-Sensitive Gap Measurements Interest-Sensitive Assets – Interest Sensitive Liabilities Dollar Interest-Sensitive Gap = Relative Interest-Sensitive Gap Interest Sensitivity Ratio
  12. Interest-Sensitive Assets Short-Term Securities Issued by the Government and Private Borrowers Short-Term Loans Made by the Bank to Borrowing Customers Variable-Rate Loans Made by the Bank to Borrowing Customers
  13. Interest-Sensitive Liabilities Borrowings from Money Markets Short-Term Savings Accounts Money-Market Deposits Variable-Rate Deposits
  14. Asset-Sensitive Bank Has: Positive Dollar Interest-Sensitive Gap Positive Relative Interest-Sensitive Gap Interest Sensitivity Ratio Greater Than One
  15. Liability Sensitive Bank Has: Negative Dollar Interest-Sensitive Gap Negative Relative Interest-Sensitive Gap Interest Sensitivity Ratio Less Than One
  16. Gap Positions and the Effect of Interest Rate Changes on the Bank Asset-Sensitive Bank Interest Rates Rise NIM Rises Interest Rates Fall NIM Falls Liability-Sensitive Bank Interest Rates Rise NIM Falls Interest Rates Fall NIM Rises
  17. Zero Interest-Sensitive Gap Dollar Interest-Sensitive Gap is Zero Relative Interest-Sensitive Gap is Zero Interest Sensitivity Ratio is One When Interest Rates Change in Either Direction - NIM is Protected and Will Not Change
  18. Important Decision Regarding IS Gap Management Must Choose the Time Period Over Which NIM is to be Managed Management Must Choose a Target NIM To Increase NIM Management Must Either: Develop Correct Interest Rate Forecast Reallocate Assets and Liabilities to Increase Spread Management Must Choose Volume of Interest-Sensitive Assets and Liabilities
  19. NIM Influenced By: Changes in Interest Rates Up or Down Changes in the Spread Between Assets and Liabilities Changes in the Volume of Interest-Sensitive Assets and Liabilities Changes in the Mix of Assets and Liabilities
  20. Cumulative Gap The Total Difference in Dollars Between Those Bank Assets and Liabilities Which Can be Repriced over a Designated Time Period
  21. Aggressive Interest-Sensitive Gap Management
  22. Problems with Interest-Sensitive Gap Management Interest Paid on Liabilities Tend to Move Faster than Interest Rates Earned on Assets Interest Rate Attached to Bank Assets and Liabilities Do Not Move at the Same Speed as Market Interest Rates Point at Which Some Assets and Liabilities are Repriced is Not Easy to Identify Interest-Sensitive Gap Does Not Consider the Impact of Changing Interest Rates on Equity Position
  23. The Concept of Duration Duration is the Weighted Average Maturity of a Promised Stream of Future Cash Flows
  24. To Calculate Duration
  25. Price Sensitivity of a Security
  26. Convexity The Rate of Change in an Asset’s Price or Value Varies with the Level of Interest Rates or Yields
  27. Duration of an Asset portfolio Where: wi = the dollar amount of the ith asset divided by total assets DAi = the duration of the ith asset in the portfolio
  28. Duration of a Liability Portfolio Where: wi = the dollar amount of the ith liability divided by total liabilities DLi = the duration of the ith liability in the portfolio
  29. Duration Gap
  30. Change in the Value of a Bank’s Net Worth
  31. Impact of Changing Interest Rates on a Bank’s Net Worth
  32. Limitations of Duration Gap Management Finding Assets and Liabilities of the Same Duration Can be Difficult Some Assets and Liabilities May Have Patterns of Cash Flows that are Not Well Defined Customer Prepayments May Distort the Expected Cash Flows in Duration Customer Defaults May Distort the Expected Cash Flows in Duration Convexity Can Cause Problems
  33. Consumer Loans, Credit Cards, and Real Estate Lending Topic
  34. Types of Consumer Loans Residential Mortgage Loans Nonresidential Loans Installment Loans Noninstallment Loans Credit Card Loans and Revolving Credit
  35. Residential Mortgage Loans Credit to Finance the Purchase of Residential Property in the Form of Houses and Multifamily Dwellings. This is Usually a Long-Term Loan Which is Secured By the Property Itself
  36. Installment Loans Short-Term to Medium-Term Loans Repayable in Two or More Consecutive Payments, Usually Monthly or Quarterly. These Are Often Used to Finance Big Ticket Purchases or Consolidate Existing Debt.
  37. Noninstallment Loans Short-Term Loans By Individuals for Immediate Cash Needs and Repayable in One Lump Sum When the Borrower’s Note Matures
  38. Credit Card Loans Credit Cards Offer Holders Access to Either Installment or Noninstallment Credit. Banks Find That the Installment Users of Credit Cards are the Most Profitable. Banks Also Earn Discount Fees From Merchants on Credit Cards.
  39. Debit Cards Debit Cards Can Be Used To Pay For Goods And Services, But Not To Extend Credit. They Are A Convenient Vehicle For Making Deposits Into And Withdrawals From ATMs And They Facilitate Check Cashing.
  40. Characteristics of Consumer Loans Most Costly and Most Risky to Make Per Dollar Cyclically Sensitive Interest Inelastic
  41. Evaluating a Consumer Loan Application Character and Purpose Income Levels Deposit Balances Employment and Residential Stability Pyramiding of Debt
  42. Credit Bureaus Credit Reporting Agencies or Credit Bureaus Assemble and Distribute to Lenders the Credit History of Millions of Borrowers Information Personal Identifying Data Personal Credit Histories Public Information That May Have Bearing on Loan
  43. Credit Scoring Credit Scoring Systems are Based on Sophisticated Statistical Models in Which Several Variables are Joined to Establish a Numerical Score to Separate Good Loans From Bad Loans. The Most Famous of These is the FICO Scoring System Developed by Fair Isaac.
  44. Laws and Regulations Applying to Consumer Loans Truth in Lending Act Fair Credit Reporting Act Fair Credit Billing Act Fair Debt Collection Practices Act Equal Credit Opportunity Act Community Reinvestment Act Home Ownership and Equity Protection Act
  45. Identity Theft Fastest Growing Crime Against Individuals Today It Can be Difficult to Detect and Costly to Recover From Fair Credit and Accurate Credit Transactions (FACT) Act was Passed to Counter this Growing Problem Consumers Entitled to One Free Credit Report Annually from Each of the Three Major Credit Bureaus
  46. Predatory Lending An Abusive Practice Among Some Lenders That Consists of Granting Loans to Weak Borrowers and Charging Them Excessive Interest Rates and Fees, Increasing the Risk of Default
  47. Real Estate Loans Among the Riskiest Loans Banks Can Make Average Size is Larger Than the Average Size of Other Loans Tend to Have Longer Maturities Than Other Loans
  48. Factors Used in Evaluating Real Estate Loans Size of Down Payment Relative to Purchase Price of Property Should Be Evaluated in Terms of Total Relationship Need to Pay Attention to Particular Aspects of Credit Application: Amount and Stability of Income Available Savings and Source of Down Payment Track Record in Maintaining Property Outlook for Real Estate Market in Local Area Outlook for Interest Rates If Variable Rate Loan
  49. Home Equity Lending Home Owners Can Use the Difference in Home’s Estimated Value and Remaining Mortgages as a Borrowing Base Two Types of Credit Closed End Credit Lines of Credit Can Be Used for Any Legitimate Purpose The 1986 Tax Reform Act Has Helped This Type of Loan Grow in Popularity
  50. Interest Only Mortgages Many of these are Adjustable Rate Mortgages Home Owner Can Pay the Interest Only for an Initial Period Mortgage Payments Can be Much Higher When Principal Payments are Due Because of the Shorter Period to Repay the Loan
  51. Cost-Plus Model of Pricing Loans
  52. Annual Percentage Rate (APR) The APR is the Internal Rate of Return that Equates Total Payments With the Amount of the Loan. The Truth in Lending Act Requires That This Rate Be Disclosed to Consumers On All Loans
  53. Simple Interest In Simple Interest the Customer Only Pays Interest On the Amount of the Principal Left. First the Declining Loan Balance is Calculated and That Reduced Balance is Used to Calculate the Amount of Interest Owed
  54. Discount Rate Method The Discount Rate Method Requires the Customer to Pay the Interest in Advance. Interest is Deducted First and the Customer Receives the Loan Amount Less Any Interest Owed
  55. Add-On Loan Rate Method Interest Owed is Added to the Principal Amount, Then the Loan Payments are Calculated By Dividing This Sum By the Number of Loan Payments
  56. Rule of 78s A Rule of Thumb to Determine Exactly How Much Interest Income a Bank is Entitled to Accrue at Any Point in Time From an Installment Loan Being Paid in Monthly Installments.
  57. Interest Rates on Home Mortgages Fixed Rate Mortgage (FRM) – 1930s to 1970s Most Mortgages Were Fixed-Rate Mortgages. They Had a Fixed Interest Rate That Did Not Change Over the Life of the Loan Adjustable Rate Mortgage (ARM) – in the Early 1970s Adjustable Rate Mortgages Were Allowed. These Mortgages Have an Interest Rate That Changes Over the Life of the Mortgage. Roughly One Quarter of All Mortgages are Adjustable Today
  58. Mortgage Points This is an Additional Up Front Charge Often Required on Home Mortgages. It is a Percentage of the Loan Amount and Reduces the Amount of the Loan Available
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