MANAGING INTEREST RATE RISK
The interest rate risk management is very important and many technical instruments have been developed to understand the interest rate risk. The interest rate risk majorly comes up in interest bearing asset like loan and bonds as there exist a possibility of change in asset’s which is the result of variability of interest rates.
FUNDAMENTAL INTEREST RATE CONSIDERATIONS
The trading of variable rate loan structure is involved during interest rate swaps having fixed rate or may be other way around. The most important thing to understand is the underlying fundamentals regarding loans before considering the possibility of proceeding with interest rate swap or any other factor that can influence the swap strategy. …show more content…
Solution
Using equation 2 :
DUR(gap)=DUR(a)-(L/A×DUR(l))
Here,
DUR(a) = average duration of assets
DUR(l) = average duration of liabilities
L = market value of liabilities
A = market value of assets
Where,
DUR(a) = 2.70
L = 95
A = 100
DUR(l) = 1.03
Thus:
DUR(gap) = 2.70 – (95/100×1.03) = 1.72 years
The bank manager uses the DUR(gap) calculation of equation 1 to estimate what will happen if interest rates changes and to obtain the change in the market value of the net worth as a percentage of total assets.
We can also say that it is the change in the market value of net worth as a percentage of assets calculated as :
ΔNW/A= -DUR(gap) ×Δi/(1+i)
Question 3
Find the change in the market value of net worth as percentage of assets if there is a rise in the interest rates from 10% to 11%?
Use equation 3 to solve this question.
Solution
Using equation 3 ΔNW/A= -DUR(gap) ×Δi/(1+i)
Here,
DUR (gap) = duration gap
Δi = change in interest rate
I = interest rate
Where given values are
DUR(gap) = 1.72
Δi = 0.11 – 0.10 = 0.01
I = 0.10
If there is a increase in the interest rates from 10% to 11% that would lead to a change in the market value of net worth as a percentage of assets of
The interest rate risk management is very important and many technical instruments have been developed to understand the interest rate risk. The interest rate risk majorly comes up in interest bearing asset like loan and bonds as there exist a possibility of change in asset’s which is the result of variability of interest rates.
FUNDAMENTAL INTEREST RATE CONSIDERATIONS
The trading of variable rate loan structure is involved during interest rate swaps having fixed rate or may be other way around. The most important thing to understand is the underlying fundamentals regarding loans before considering the possibility of proceeding with interest rate swap or any other factor that can influence the swap strategy. …show more content…
Solution
Using equation 2 :
DUR(gap)=DUR(a)-(L/A×DUR(l))
Here,
DUR(a) = average duration of assets
DUR(l) = average duration of liabilities
L = market value of liabilities
A = market value of assets
Where,
DUR(a) = 2.70
L = 95
A = 100
DUR(l) = 1.03
Thus:
DUR(gap) = 2.70 – (95/100×1.03) = 1.72 years
The bank manager uses the DUR(gap) calculation of equation 1 to estimate what will happen if interest rates changes and to obtain the change in the market value of the net worth as a percentage of total assets.
We can also say that it is the change in the market value of net worth as a percentage of assets calculated as :
ΔNW/A= -DUR(gap) ×Δi/(1+i)
Question 3
Find the change in the market value of net worth as percentage of assets if there is a rise in the interest rates from 10% to 11%?
Use equation 3 to solve this question.
Solution
Using equation 3 ΔNW/A= -DUR(gap) ×Δi/(1+i)
Here,
DUR (gap) = duration gap
Δi = change in interest rate
I = interest rate
Where given values are
DUR(gap) = 1.72
Δi = 0.11 – 0.10 = 0.01
I = 0.10
If there is a increase in the interest rates from 10% to 11% that would lead to a change in the market value of net worth as a percentage of assets of