FINS3630 Lecture Notes - Lecture 5: Interest Rate Risk, Canons Regular, Reinvestment Risk
Lecture 2: Interest rate risk
- FI perform maturity intermediation between households and firms → LT IR fixed vs.
deposit IR (rolled over) vary w market IR
- Measure of effets of IR ∆: Net interest income (interest income – interest expenses) →
repricing model (rollover of asset or variable rate instrument)
o Net worth: MV A – MV L → duration model
- Central banks influence ST rates (but this transfers to LT rates)
- Rate sensitive A/L (RSA/RSL- repriced w/in maturity bucket)
o Maturity buckets: 1 day, >1d-3m, >3m-6m, >6m-1y, >1y-5y, >5y
o Reasons for repricing: rollover of A, variable rate instrument
o Repricing GAP(i) = RSA(i) – RSL(i)
▪ When negative: RSA<RSL in bucket I → -ve GAP esp CGAP exposes FI to
refinancing risk
▪ Positive exposes FI to reinvestment risk
o Cuulatie CRSA = ∑RSA or L
o Cuulatie repriig gap: CGAP = ∑GAP
o ∆NII = GAPi ∆Ri
o ∆CNII = ∑∆NII
o gap ratio: CGAP(i)/Assets → standardise
o assue ∆rRSA ≠ ∆rRSL ie spread effet
▪ ∆NII = RSA*∆rRSA – RSL*∆rRSL at i
▪ ∆CNII = CRSA*∆rRSA – CRSL*∆rRSL at i
- weakness of repricing model: 21-25
o run-off problem
o ignorance of OBS activities
o ignores distribution of A/L w/in maturity bucket and over-aggregation
o does not consider MV effects
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- duration
o duration depends purely on how its price is determined by IR → sesitiit of MV ∆
of the fiaial istruet to a ∆ i IR IR elastiit
o
o macaulay duration:
o modified duration: mD = D/1+r
o dollar duration: DD = MD*P
o zero coupon bonds: sell at the deepest discount (CPN rate cannot go below zero)
o higher cpn = lower duration
Interest rate risk II
- coupons = lower duration (receive PV of CF earlier)
- duration increases maturity
-
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Fi perform maturity intermediation between households and firms lt ir fixed vs. deposit ir (rolled over) vary w market ir. Measure of effe(cid:272)ts of ir : net interest income (interest income interest expenses) repricing model (rollover of asset or variable rate instrument: net worth: mv a mv l duration model. Central banks influence st rates (but this transfers to lt rates) Weakness of repricing model: 21-25: run-off problem ignorance of obs activities ignores distribution of a/l w/in maturity bucket and over-aggregation, does not consider mv effects. Interest rate risk ii coupons = lower duration (receive pv of cf earlier) Duration of annuity: duration of annuity does not matter on cf, is influenced by rates and pattern of cf consul bond = perpetuity. Duration: degree to which changes in interest rates change of value of asset immunisation: d(a) = d(l) = wx*dx + wy*dy.
