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Interest/Maturity Gap
G & K Chp. 5
Why Gap?
Maturity Pattern and Interest Rate Sensitivity of Assets and Liabilities differ. Fixed Rate Investment funded by Floating Rates can create Spread Squeezes. Want to create stable Spread, and force maximum funds through Changes in interest rates compound spread management by imparting value management in addition.
Trough: Low economic activity; low demand for funds, high demand for safe, liquid investments Low relative rates, + - curve Growth to Peak: Increasing economic activity; high demand for funds, low demand for interest-rate investments Higher relative rates, + - to flattening curve SlowdownTrough; Slowing economic activity, early high demand for funds gives rise to drop off High rates drop, with inverted-curve returning to positive slope
Maturity Gap
Repricing of Book Values of Assets vs. Liabilities in common time periods Pg. 5 of any output
Rate Sensitive Assets (RSAs) and Rate Sensitive Liabilities (RSLs) 3, 6, 9 mo., 1 yr., 1-3 yrs., Over 3 yrs.
Maturity Gap
Rates Go Up
Positive Gap Increase NII Negative Gap Decrease NII
Rates Go Down
Positive Gap Decrease NII Negative Gap Increase NII
Problems:
Ignores Market Value Changes Ignores variation in intra-bucket value changes Concentrates on single-period CF, not MV
Maturity Gap
Y1Q4:
3 month Assets: 3596.96 3 month Liabilities: 2617.51 RSA RSL = 3 month Gap = 979.45
Duration Gap
Duration Weighted Assets and Liabilities Managing the Change in Equity (Value) from a change in interest rates and their effect on Assets and Liabilities Remember: Price = - D * r / (1 + YTM) * Price Applied to Assets and Liabilities: A = - DA * R / (1 + R) * A L = - DL * R / (1 + R) * L
Duration Gap
Then: E =
A -
E = -[ DA - DL (L/A)] * [R/(1+R)] * A
Change in Equity is negative of difference in durations multiplied by interest rate change multiplied by asset base
Duration Gap
Rates Go Up
Positive Duration Gap Decrease Value Negative Duration Gap Increase Value
Rates Go Down
Positive Duration Gap Increase Value Negative Duration Gap Decrease Value
Duration Gap
From 1.4 Output: Assets: Duration = 0.427 , Value = $4.897 bill Liabs: Duration = 1.103, Value = $4.609 bill