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LIQUIDITY
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DOLLAR GAP
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DOLLAR GAP
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EFFECT OF INTEREST RATE CHANGES
ON DOLLAR GAP
I S $ i ö S $ i ap i
ö ö
ö :
( Õ
measure the gaps for different
maturity ´bucketsµ (e.g., 0-7 days, 8-30 days, 31-90
days, and 91-365 days).
( @
add up the incremental gaps from
maturity bucket to bucket.
EXAMPLE
7 7 7 7
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9
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:% :$ :$ :& :%' :&'
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RATE SENSITIVITY REPORTS
( Periodic GAP
÷ Gap for each time bucket.
÷ Measures the timing of potential income
effects from interest rate changes.
( Cumulative GAP
÷ Sum of periodic GAP's.
÷ Measures aggregate interest rate risk over the
entire period.
( Examine Exhibit 8.5:
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MANAGING INTEREST RATE RISK 'ITH DOLLAR
GAPS
( "/3/': To guard
against changes in NIM (e.g., near zero gap).
( m'' 3/':
È Interest rates
Market value of equity falls
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CALCULATING DURATION
( Step 1: Identify Interest rate sensitive assets
and liabilities. Additionally, non ² interest rate
bearing items can also be included in calculation.
( Step 2: Calculate the MTM value for all the rate
sensitive assets.
( Step 3: Calculate the MTM value for all the rate
sensitive liabilities.
( Step 4: Calculate the duration for each asset and
liability of the on-balance sheet portfolio. This is
calculated using Macaulay Duration.
MACAULAY DURATION
p
p
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MACAULAY DURATION
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CALCULATING DURATION
Step 5: Calculate the aggregate weighted average
duration of assets and liabilities.
'eighted Average Duration of Assets (DA) = 'aDa
'eighted Average Duration of Liabilities (DL) = 'lDl
'here,
' a = market value of the asset ¶a·(MTM) divided by
market value of all the assets (Net MTM)
' l = market value of the liability ¶l·(MTM) divided by
the market value of all the liabilities (Net MTM)
Da = duration of asset ¶a·
Dl = duration of liability ¶l·
CALCULATING DURATION
Step 6: Calculate the duration GAP using the
following formula:
"m6"m7 "B m
'here,
DA is the weighted average duration of assets,
DL is the weighted average duration of liabilities,
MVL is the total MTM of liabilities,
MVA is the total MTM of assets.
MODIFIED DURATION
( Modified duration is a measure of the price
sensitivity of a bond to interest rate movements.
It is calculated as shown below:
Modified Duration = Macaulay Duration /( 1 +
y/n), where y = yield to maturity and n = number
of discounting periods in year ( 2 for semi - ann
pay bonds )
Then, % Price Change = -1 * Modified Duration *
Yield Change
Ú
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( Defensive
÷ Immunize net worth of bank
÷ Duration gap ~ 0
( Aggressive
÷ Use forecast of interest rate changes to manage bank net
worth
DURATION GAP HEDGING
( Positive gap
÷ Reduce duration of assets
÷ Increase duration of liabilities
÷ Short position in financial futures
( Negative gap
÷ Increase duration of assets
÷ Decrease duration of liabilities
÷ Long position in financial futures
PROBLEMS 'ITH DURATION GAP
( Simulation models
) V
& V
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+
*
32*'0 *0 32'()0 -2- )-2+
The total of ten constraints are there according to the conditions specified.
The equation becomes:
Subject to:
( 1.00 w1 +0.00 w2 + 0.00 w3 + 0.00 w4 + 0.00 w5 < 0.32
( 0.00 w1 +1.00 w2 + 0.00 w3 + 0.00 w4 + 0.00 w5 < 0.32
( 0.00 w1 +0.00 w2 + 1.00 w3 + 0.00 w4 + 0.00 w5 < 0.32
( 0.00 w1 +0.00 w2 + 0.00 w3 + 1.00 w4 + 0.00 w5 < 0.32
( 0.00 w1 +0.00 w2 + 0.00 w3 + 0.00 w4 + 1.00 w5 < 0.32
( 1.00 w1 +0.00 w2 + 0.00 w3 + 0.00 w4 + 0.00 w5 < 0.12
( 0.00 w1 +0.00 w2 + 1.00 w3 + 1.00 w4 + 0.00 w5 < 0.50
( 0.50 w1 +8.80 w2 + 9.90 w3 + 5.60 w4 + 7.60 w5 < 7.20
( 0.50 w1 +18.50 w2 + 19.40 w3 + 7.30 w4 + 24.40 w5 < 1.00
And
( w1 , w2 , w3 , w4 , w5 > 0
( Using a linear programming software we get following
result
)42*0
*&0
)30
*&0
/ '240