What can bank do to correct a liability sensitive position?
Asset securitization - bank pools loans & sells them to FNMA, etc., then sells a security based on the pool.
RSA/RSL of 1.00, still not immune to IRR because why?
balanced ratio.
Effect of Gap on Earnings (5.2-5)
(RSA-RSL)/Assets X change in rates = change in ROA on annualized basis. Example in manual (5.2-5) gives GAP to Assets of 20% and rates fall by 1%. ROA will decline .2% or 20% X .01
A bank's Asset/Liability Management Committee has positioned the bank to take advantage of projected interest rate movements. As a result of this positioning, the bank has a GAP to Total Assets ratio of 25%. Which of the following is true:
·The bank is asset sensitive because the volume of RSA exceeds that of RSL.
·The bank is liability sensitive because RSL exceeds RSA.
A bank's ALCO had positioned the bank to take advantage of projected interest rate movements. As a result of this positioning, the bank had a GAP to Total Assets ratio of 25%. Shortly after this, interest rates dropped 250 basis points within 60 days. The impact on the bank's net interest margin was most likely which of the following?
·The NIM decreased because the bank was asset sensitive and a greater volume of assets repriced at lower rates.
·The NIM decreased because the bank was liability sensitive and a greater volume of liabilities repriced at lower rates.
(.25 X .025)
A perfectly matched gap = 0. A perfectly matched RSA / RSL = 100.
What are the potential risks of asset management?
a.overpaying for borrowings when needed
b.paying a high rate for deposits
(a & b are liability management)
Other risk - long term fixed rate loans and securities could cause a mismatch with short term liabilities.
What are the risks associated with liability management?
(1) Purchased funds may not always be available when needed
(2) Minimal amount of short-term securities and large concentration of short-term liabilities
(3) May have to pay higher rates due to competition, may accept riskier loans and securities
(4) Monetary tightness may limit ability to borrow
(5) Basing borrowing considerations on cost may intensify a bank's liability sensitive position.
A bank has limited control over the volume of its fixed rate liabilities. Therefore, to achieve balance would likely require a run-off of rate sensitive liabilities and a reduction in fixed rate/long term loans or securities supported by these liabilities. This may be difficult since the rising rates indicate the likelihood of a capital loss from the sale of fixed-rate assets.
Calculate a bank's GAP position given a repricing schedule.
Of the recommendations in the manual to include in the ALCO policy, what would be the most useful to combat the failure of the bank to monitor its position and the positive VLD?
Include target ratio in its policy for dependency and/or parameters AND MONITOR.
ALCO committee
What are the areas of A/L Policy should cover? (6.1-4)
(1)Provide for an A/L Committee. Define who will be on the committee. How often it will meet, as well as its responsibilities.
(2)provide for periodic review of the bank's deposit structure and rates.
(3)Provide for a method of computing the bank's cost of funds
(4)Provide for a method of loan pricing. Determine when to use fixed vs. floating rates.
(5)Determine mix and permissible investments and loans
(6)Determine which types of loans are permitted & desirable, the desired mix, volume compared to total deposits and total loans, upcoming maturities, and loan commitments outstanding.
(7) Target ratio for dependency and/or parameters
(8)Target ratio for RSA / RSL and GAP as a % of total assets
(9)Review performance with the bank's target liquidity ratio. Review compliance with legal reserves.
(10)Review possible alternative sources of funds
(1)Define responsibility and authority for functional areas.
(2)Establish risk limits with respect to net interest income and market value.
(3)Establish an IRR measurement and monitoring system.
(4)Establish reporting requirements.
(5)Establish internal control procedures.
(1)Capital adequacy
(2)Asset/liability mix
(3)Economic outlook
(4)Market characteristics
(5)Interest rate forecast
What is the definition of GAP?
Rate sensitive assets minus rate sensitive liabilities divided by total assets.
Static gap analysis can reveal large maturity and repricing mismatches and can provide an estimate of the effect of interest rate changes on a bank's net interest income.
Gap analysis, however, is limited in that this analysis focuses on short-term mismatches and not the full maturity spectrum. Gap analysis also assumes that interest rates change one time (static change) over the life of an instrument and that rates in all maturities will change at the same magnitude (parallel rate shifts). Because market values are not in gap analysis, the change in MV of a bank cannot be determined.
Compensate for increase in variable liabilities?
What are the effects of a (RSA - RSL)/ Assets of 20%?
If management anticipates rising rates and if the interest rate predictions prove incorrect and fall by 1%, the bank's ROA will decline on an annualized basis by .2% (.20 x .01)
The same 1% fall in interest rates would have less of an impact on ROA when (RSA - RSL)/Assets is 5%. In this case, the 1% fall in interest rates would cause a decline in ROA on an annualized basis of only .05% (.05 X .01)
This question was either a gimme or a trick . . . I don't know which one! I was given (in the separate test booklet) a balance sheet with repricing information. It looked similar to this:
6-months12-months
Interest-bear. Bal. xxxxx xxxxx
FFS xxxxx xxxxx
Loans xxxxx xxxxx
Securities xxxxx xxxxx
TOTAL ASSETS xxxxx xxxxx
FFP xxxxx xxxxx
Deposits xxxxx xxxxx
TOTAL LIABILITIES xxxxx xxxxx
I don't remember the exact accounts, but they were all very straightforward, and ALL were repriceable. I was asked what the net position of assets (liabilities) was in the one year time horizon (i.e., TA minus TL). I just thought that it seemed like a trick question because the entire balance sheet was repriceable. All I had to do was take the totals that were already calculated and subtract one from the other. BEWARE: There was a typo on this question. On the liability side of the B/S, FFP were mistakenly written as FFS; however, I know this was only a typo because when I tried to make appropriate adjustments, the correct answer was not a choice.
How will the change in interest rates effect a bank with a RSA/RSL of 1. (5.2-4)
T or F An asset sensitive bank has more options than a liability sensitive one? (5.2-5)
Adjust appropriately (premises, DDA, nonliabs) and calculate RSA/RSL & Gap
Remember, regular chk accts are not sensitive. Exclude premises and nonliabs like capital.
Situation involving problematic IRR - the bank/Board was not monitoring its position and the bank was VLD positive. What should be included in the ALCO policy in order to correct the problem - 5 correct answers are given and you pick the three most useful in this situation (See 6.1-14)?
Given an IRR scenario, choose between five items what a bank could do to improve a liability-sensitive position?
1 - Invest in more floating-rate & short-term loans & securities
2 - Accept less brokered deposits, attract core deposits
3 - If Board approved, explore interest rate swaps
What is the effect on net income (i.e. increase or decrease) if the net gap position is 25% and (30%)?
Effect = Position x (increase or decrease)
RSA - RSL / Assets = .25 or (.30) Remember: For IRR Gap, exclude non-sensitive
Fall 2%: 25% x (.02) = (.5%) Fall or -.5% on ROA accounts (reg chk, premises, etc.)
Rise 2%: 25% x .02 = .5% Rise or .5% on ROA
Fall 2%: (30%) x (.02) = .6% Rise or .6% on ROA
Rise 2%: (30%) x .02 = (.6%) Fall or -.6% on ROA
Asset/Liability management - Be able to differentiate between asset management techniques and liability management techniques. Scenario where you need to select strategies consistent with the stated goal which are either asset or liability management techniques.
Know effects of duration on income, asset/liability, etc.
Know effects of certain GAP scenarios on NIM.
Duration analysis (calculations). Know the effects of long duration on assets and shorter on liabilities
Given a financial statement, calculate RSA/RSL.
(RSA-RSL)/Assets net position (25%); 200 bps decline in interest rates. What happens?
Duration analysis question - interpretation of duration GAP and effect.
IRR scenario - rates declining. What would happen?
Assets Subject to Interest Rate Adjustment Within Time Horizon
Loans & Leases: (EXCLUDE non-accrual loans)
Fixed rate by maturity
Floating rate by repricing interval
Scheduled payments due-other loans
Securities:
Fixed rate by maturity
Floating rate by repricing interval
Interest Bearing Funds
Federal Funds Sold and Repos
Other:
Repurchase agreements - Securities purchased under agreement to resell (reverse repo)
Stripped MBS, residuals
Trading account activities (IOs & POs)
Purchased floors - convert floating rate to fixed rate asset (notional amt x delta)
Purchased calls & written puts - delta equiv.
Sold forward rate agreements
Liabilities Subject to Interest Rate Adjustment Within Time Horizon
Transaction Accounts
Money Market Deposit Accounts
Other Savings Accounts (reg & nows)
Brokered Deposits
Other Time Deposits $100M & Over
Other Time Deposits Under $100M
Deposits Held In Foreign Offices (Edge Corps & IBFs)
Federal Funds Purchased and Repos
Other Borrowings:
Securities sold under agreement to repurchase
Long Term Debt
Other
Notional amt. of IR swap if converting floating rate liab to fixed rate liab.
Purchased caps that convert floating rate liab. to fixed rate liab.
Futures hedge if it lengthens liabs.
Purchased puts & written calls (notional amt x delta)
Purchased forward rate agreements (buy = fixed borrowing cost)
Total
Net position of assets (liabilities)
Net position as a percent of total assets
RSA as a % of RSL
(Total interest rate sensitive liabilities does not include regular checking accounts)
FOR THE FOLLOWING DURATION PROBLEMS, REVIEW DR. HANDORF'S DURATION LECTURE FROM SCHOOL 2.
Calculate Duration
Assets of $10MM with duration of 7.4 and liabilities of 3.8 what happens with change of rates?
Change in market value approx. equals -D time change in interest rates times market value. The example in the DOS manual give RSA of $10M RSA with a duration of 7.5 years and $10M in RSL with a duration of 2.6 years. The bank is liability sensitive since average life of assets is 4.9 years longer than liabilities. 4.9 year difference is duration gap. Thus, for every 1% increase in rates there would be an approximate $490 or 4.9% decrease in present value of the portfolio (-4.9 X .01 X $10M).
Note: the safest way to do this calculation is to calculate assets and liabilities separately.
-3.60 x .01 x $10MM = -$360M
OR
$360M
Assets of $10MM with a duration of 7.4 and $10MM of liabilities of 3.8.
a.Since the duration for assets is shorter than the duration for liabilities, the bank is asset sensitive
b.If rates rise 1% then the value of the bank's assets will increase by $360M
c.Since the duration of the assets is longer than the duration of liabilities, the bank is liability sensitive. If rates rise by 1% then the value of the bank's assets will decrease by $360M.
d. One other choice
-3.60 x .01 x $10MM = -$360M
A bank's asset portfolio has a duration of 7.5 years. The bank's liabilities have a duration of 4.7 years. Both portfolios have $10,000. What are the possible effects if interest rates increase 1%?
7.5 - 4.7 = 2.8
-2.8 x .01 x 10M = -$280
If the duration of assets exceeds the duration of liabilities, a bank is exposed to the consequence of rising interest rates.
If the duration of liabilities exceeds the duration of assets, a bank is exposed to the consequence of falling interest rates.
Duration: Assets = $10MM w/duration of 7.5 years, Liabilities = $10MM w/duration of 4.0 years. Which is true? (Also know dollar amount changes - $350, etc.)
1) Bank is asset sensitive.
2) For every 1% change in rates then the value of the assets will vary by $350M or 3.5%
3) As rates increase the value of assets will increase
4) Bank should get more long-term assets
(2) is correct. 7.5 - 4 = 3.5 (Liab Sensitive - Shorter Liab Life)
(1) is wrong because its liab sensitive.
(3) is wrong because assets value will decrease when compared to higher returning assets.
(4) is wrong because short-term assets are needed.
The duration of an asset or liability is affected by numerous factors. Duration is shorter when:
Duration Analysis - Assets Duration = 7.5 years & Liabilities Duration = 5 years. If interest rates rise 1%, all of the following will be true except:
1) Bank is liability-sensitive
3) Interest income will increase
7.5 - 5 = 2.5 (Liability Sensitive - Shorter Liability Life)
Interest Income will increase, but not as much as liabilities
Therefore, (2) is incorrect. Asset market value will decrease
^P = -D (^i) (P) | D = ^ in Assets - ^ in Liabs | D = PV x T = PVT | PVT/PV = D
^P = -2.5 (1%) (10,000) = -$250 (Decrease in Value of Assets)
Bank is liability sensitive if duration of assets is longer than liabilities
Bank is asset sensitive if duration of liabilities is longer than assets
Early return of cash >>>>> shorter duration
Calculate duration when given a table like in the DOS manual.
PV x T
PV
Review the box in the manual that illustrates a simple duration calculation for a bond. The test question just shows the box and asks what the duration is.