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ALM-Dec09

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					    ASSET
  LIABILITY
MANAGEMENT
          TYPES OF GAPS
• DOLLAR GAP
• MATURITY GAP
• DURATION GAP
                DOLLAR GAP
• It is measured over a certain time period
• For example : six months
• $ GAP = RSA – RSL
• RSA; Rate (interest) Sensitive Assets
• RSL; Rate (interest) Sensitive Liabilities
• RSA= Assets ($), reset during the next six
  months
• RSL= Liabilities($), reset during the next six
  months
                MATURITY BUCKETS
                              120 -
              0 - 60 60 - 120 180     Cumulative

              Days    Days    Days

Assets        $10      $40     $20       $70

Liabilities   $20      $35     $50      $105

Gap           $(10)    $5     $(30)     $(35)
              DOLLAR GAP
• If Gap is +ve
• When Interest Rates Rise NII
• When Interest Rates Fall NII

• If Gap is –ve
• When Interest Rates Rise NII
• When Interest Rates Fall NII
              DOLLAR GAP
• The US Central Bank (FED) requires reporting
  of dollar gap on quarterly basis
• 1 day
• 2-90 days
• 3 – 6 months
• 6 months – 12 months
• 1 – 5 year
• > than 5year
               MATURITY GAP
•   Consider three bonds A, B, and C
•   Face value of each is $100
•   Coupon rate = 10% p.a. (annual payment)
•   Coupon amount = $10
•   Maturities; A-1yr, B-2yr, and C-3yr
•   Price (Value) of Bonds if market rates of
    interest increase to 11%
                   MATURITY GAP
BOND MATURITY   FACE VALUE       PRICE “Pn”
                       P₀    Interest Rate = 11%     P₀ – Pn   Pn – Pn-1
A    1 – YEAR   $ 100        $ 99.10               $ 0.90      $ 0.90
B    2-YEARS    $100         $ 98.29               $ 1.71      $ 0.81
                                                               1.71 – 0.9
C    3-YEARS    $ 100        $ 97.56               $ 2.44      $ 0.73
                                                               2.44 – 1.71



The price of B falls more than the price of A
Price of C falls more than the price of B
The longer the maturity, the larger the decline
The fall increases at a diminishing rate
                         Maturity GAP
ASSETS          LIABILITIEs        ASSETS           LIABILITIES
BOND $ 100      Deposit $90        Bond $ 97.56     Deposit $ 89.19
                Equity        10                    Equity    10.00
Total    $100   Total     $100     Total    $ 97.56 Total    $ 99.19
               MATURITY GAP
•   Maturity Gap = MA – ML
•   MA = Wa1XMa1 + Wa2XMa2 ….
•   ML = WL1XML1 + WL2XML2 ……….
•   If Maturity Gap is +ve
•   When Interest Rates Rise, Bank loses
•   When Interest Rates Fall, Bank gains
•   If Maturity Gap is –ve
•   When Interest Rates Rise Bank Gains
•   When Interest Rates Fall Bank loses
             MATURITY GAP
• Setting Maturity Gap = 0
• It does not insulate a bank completely from
  interest rate risks
• Reasons why some risk remain
  – Amounts not matched
  – Rates may not move together exactly for assets
    and liabilities
  – Timing of cash flows not considered. This aspect is
    resolved through “duration”
                     DURATION GAP
ASSETS       AMOUNT DURATION LIABILITIES AMOUNT   DURATION
ST securities $150      0.5   Demand     $400        0.0
                              Deposits
LT securities $100      3.5   ST         $350        0.4
                              Deposits
Floating     $400       0.0   LT Deposits $150       2.5
Rate Loans
Fixed Rate   $350       2.0   Equity     $100       0.00
Loans
 Duration of an Asset portfolio

                            n
                D A   w i * D Ai
                          i 1


   Where:
wi = the dollar amount of the ith asset divided by total assets
DAi = the duration of the ith asset in the portfolio
   Duration of a Liability Portfolio

                                n
                      D L   w i * D Li
                               i 1



    Where:
wi = the dollar amount of the ith liability divided by total liabilities
DLi = the duration of the ith liability in the portfolio
  Duration Gap



              TL
D  DA - DL *
              TA
            DURATION GAP
• If Duration Gap is +ve
• When Interest Rates Rise, Bank loses
• When Interest Rates Fall, Bank gains

• If Duration Gap is –ve
• When Interest Rates Rise Bank Gains
• When Interest Rates Fall Bank loses
                  DURATION
• Weighted average of times to each coupon or
  principal payment on a bond
• It serves as a useful summary statistic of the
  Effective Maturity of Bond
• It also serves as a guide to the sensitivity of a
  bond to interest rate changes
                  Duration
• Holding Maturity constant, Duration increases
  as coupon rate is lower
• Holding coupon rate constant, duration
  increases as maturity increases
• Duration increases when Bond’s YTM is lower,
  OTRC
• Longer the duration, more volatile is the bond
  price and vice – a- versa
• For zero coupon bond, maturity = duration

				
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