Liquidity and Treasury Risk Measurement and Management Flashcards
The proportional bid–offer spread
Cost of liquidation
- α is the dollar (mid-market) value of the position
- s is the proportional bid–offer spread
- n is the number of positions
Cost of liquidation (stressed market)
* α is the dollar (mid-market) value of the position
- Define ui and σi as the mean and standard deviation of the proportional bid–offer spread for the ith financial instrument held
- The parameter λ gives the required confidence level for the spread
The liquidity coverage ratio (LCR)
The net stable funding ratio (NSFR)
The leverage ratio
The leverage effect
- re = equity return
- r<span>d</span> = cost of debt
- L = leverage
Tax equivalent yield (TEY)
Net after-tax return on municipals
Tax advantage of a qualified bond
Financial firms net liquidity position
The interest cost for both Fed funds and repurchase agreements
Certificate of deposit interest rate
Available funds gap (AFG)
Effective cost rate on deposit and nondeposit sources of funds
The average cost approach to LTP (Liquidity Transfer Pricing) two major defects
- It neglects the varying maturity of assets and liabilities by applying a single charge for the use and benefit of funds
- It lags changes in banks’ actual market cost of funding
Funds Transfer Price (FTP)
- Base rate = rate depicted from the swap curve corresponding to the asset’s contractual/ behavioural maturity or repricing term, whichever is less
- Term liquidity premium = spread between the swap curve and the bank’s marginal cost of funds curve based on the contractual/ behavioural maturity of the asset
- Liquidity premium = cost of carrying liquidity cushion averaged over total assets of the bank
Bank discount rate
Convert the bank discount rate to the yield-to-maturity
Net interest margin (NIM)
Interest-sensitive gap (IS gap)
Relative IS Gap ratio
Interest Sensitivity Ratio (ISR)
- Interest sentsitive assets (ISA)
- Interest sensitive liabilities (ISL)
Net interest income
Duration formula
Price change relation do duration
Leveraged adjusted duration gap
Three key biases cause people to overstate expected returns and understate the risk of illiquid assets
- Survivorship bias
- Infrequent sampling
- Selection bias
There are four ways an asset owner can capture illiquidity premiums
- By setting a passive allocation to illiquid asset classes, like real estate
- By choosing securities within an asset class that are more illiquid, that is by engaging in liquidity security selection
- By acting as a market maker at the individual security level
- By engaging in dynamic strategies at the aggregate portfolio level
Repo haircut
Haircuts are the repo market’s way of imposing a margin on the collateral seller. Here is a simple example. Suppose a haircut of 2% is applied to a repo trade where the market value of the collateral is $10m. The seller only receives $9.8m from the buyer and the repo interest is calculated on $9.8m.
Repo cash flows
- Cash inflow = Notional * (current bond price% + coupon rate * time since last coupon) * (1 - haircut)
- Cash outflow = Cash inflow * (1 + repo interest)
Reverse REPO
A reverse repo is a short-term agreement to purchase securities in order to sell them back at a slightly higher price.
Sell the REPO
- When financing a purchase of securities, financial institutions often sell the repo to avoid putting up full purchase price for the securities.
- Selling the repo is the same as entering into a repo agreement, where the security is sold and bought back later.
Capacity ratio
= net loans and leases / total assets
Real-life liquidity risk failures
- Northern Rock in 2007 - Negative public perception of emergency borrowing from the central bank can cause a bank run.
- LTCM in 1998 - Positive feedback trading in illiquid instruments can cause excessive losses.
- Metallgesellschaft in 1993 - Hedging liabilities by rolling forward futures contracts may create cash flow mismatches.
