CH7 - Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques Flashcards
Define: Interest rate risk
refers to the volatility in net interest income attributable to changes in the
level of interest rates and shifts in the composition and volume of bank assets and liabilities
Why is Asset and Liability Management (ALM) important?
provides financial institutions with defensive weapons to handle such challenging events as business cycles and seasonal pressures and with offensive weapons to shape portfolios of assets and liabilities in ways that promote each institution’s goals
Define: Asset and Liability Management (ALM)
A managerial process to address the risk faced by banks due to the
mismatch between its assets and liabilities
What does Asset and Liability Management (ALM) do?
Manages liquidity and interest rate risk
Help addresses capital adequacy
Assists the treasury department in liquidity and interest rate management process
Assist in hedging and compliance processes
How does ALM assist in recommendation process regarding balance sheet actions?
Setting limits on the maximum size of major asset/liability categories;
Pricing of loans and deposits
Correlating maturities and terms
What does ALM help with?
Helps to provide better cash flow and liquidity management and control over
NII, NIM and EVE over the long-run
What are the two types of ALM frameworks?
Static
Dynamic
Explain: Static
Identifying and managing current existing risks to maximizing profits
Explain: Dynamic
Identifying and managing future events and to manage the mix of assets and liabilities
What are the three strategies under ALM?
Asset Management Strategy
Liability Management Strategy
Funds Management strategy
What is Asset Management Strategy?
control over assets, no control over liabilities
What is Liability Management Strategy?
control over liabilities by changing rates and other terms
What is Funds Management strategy?
work with both asset and liability management strategy
What is the problem with managing the asset and liability side of a balance sheet?
Maturity Gap
Define: Maturity Gap
The mismatch between assets and liabilities in terms of maturity
What is the effect of interest rate movement?
Interest rate movements can influence revenues, costs, market
value of assets or liabilities and the net worth
List 3 examples of Repriceable Assets
- Short-term securities issued by government and private borrowers (about to mature)
- Short-term loans made to borrowing customers (about to mature)
- Variable-rate loans and securities
List 3 examples of Repriceable Liabilities
Borrowings from the money market
Short-term savings account
Money-market deposits
List 3 examples of non-repriceable Liabilities
Demand deposits
Long-term savings and retirement accounts
Equity capital provided by the financial institutions owners
List 4 examples of non-repriceable Assets
Cash in the vault and deposits at the Central Bank
Long-term loans made at a fixed interest rate
Long term securities carrying fixed rates
Buildings and Equipment
What is interest rates?
The price of money
Opportunity costs for investing
The return on an investment
List the two economic theories are used to determine interest rates
The liquidity preference theory
The loanable fund theory
