Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
1
Learning Objectives
• Describe interest rate risk and its forms
• Identify the components of an interest
rate risk exposure management system
• Explain the interest rate risk management principle of asset repricing before liabilities • Describe the interest rate risk measurement models repricing gap analysis, duration (and convexity)
• Outline internal and external interest rate risk management techniques
Copyright 2003 McGraw-Hill Australia Pty Ltd
Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
2
Chapter Organisation
14.1
14.2
14.3
14.4
Introduction
Interest Rate Risk
Exposure Management Systems
Assets Repriced Before Liabilities
Principle (ARBL)
14.5 Pricing Financial Securities
Copyright 2003 McGraw-Hill Australia Pty Ltd
Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
4
14.1 Introduction
• Chapter 13 considered the
– Macro-economic context of interest rates
– Loanable funds approach to interest rate determination – A number of theories that explain the shape of the yield curve
• Unknown is the timing and extent of
interest rate changes
• Interest rate risk needs to be managed
Copyright 2003 McGraw-Hill Australia Pty Ltd
Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
5
Chapter Organisation
14.1
14.2
14.3
14.4
Introduction
Interest Rate Risk
Exposure Management Systems
Assets Repriced Before Liabilities
Principle (ARBL)
14.5 Pricing Financial Securities
Copyright 2003 McGraw-Hill Australia Pty Ltd
Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
6
14.2 Interest Rate Risk
• Interest rate risk takes two forms
– Reinvestment risk
–
Impact of a change in interest rates on a firm’s future cash flows
Price risk
Impact of a change in interest rates on the value of a firm’s assets and liabilities
An inverse relationship exists between interest rates and security prices i.e. a rise in interest rates results in a fall in the value of an asset or liability, or vice versa
Copyright 2003 McGraw-Hill Australia Pty Ltd
Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
7
14.2 Interest Rate Risk (cont.)
• Interest rate risk exposures may also
be described as
–
Direct
–
Reinvestment and price risk
Indirect
Relate to the future actions of market participants e.g. a rise in interest rates causes borrowers to seek new loans elsewhere and/or repay existing loans
Copyright 2003 McGraw-Hill Australia Pty Ltd
Copyright
2003
McGraw-Hill
Australia
PtyViney
Ltd
PPT Slides t/a Financial
Institutions,
Instruments and Markets
4/e by Christopher
Slides prepared by Anthony Stanger
8
14.2 Interest Rate Risk (cont.)
• Interest rate risk exposures may also
be described as (cont.)
–
Basis
Occurs when pricing differentials exist between markets e.g. futures market and the
