Bank Management and Financial Services – Ch 7

Asset Liability Management (ALM)
provides financial institutions with defensive weapons to handle such challenging events as business cycles and seasonal pressures and with offensive weapons to shape portfolios of assets and liabilities in ways that promote each institution’s goals.
Asset Management
held that the amount and kinds of deposits a depositor institution held and the volume of other borrowed funds it was able to attract were largely determined by its customers.
Liability Management
goal is to simply gain control over funds sources comparable to the control financial managers had long exercised over their assets only.
Funds Management
focuses on both asset management and liability management
Interest Rate Risk
One of the toughest and potentially most damaging forms of risk that all financial institutions must face
Yield to Maturity
the discount rate that equalizes the current market value of a loan or security with the expected stream of future income payments that the loan or security will generate
Bank Discount Rate
often quoted on short-term loans and money market securities (such as Treasury bills).
Default Risk Premium
component of the interest rate charged a risky borrower
Inflation Risk Premium
compensates in the the projected loss in purchasing power
liquidity risk
compensates for the difficulty occasionally associated with putting funds into a financial instrument
call risk
arises when a borrower has the right to pay off a loan early, possibly reducing the lender’s expected rate of return if market interest rates have fallen
Yield Curve
the graphic picture of how interest rates vary with different maturities of loans viewed at a single point in time
Maturity gap
experienced when a gap exists between the average maturity of assets and average maturity of liabilities
Net Interest Margin
NIM=(interest income-interest expense)/total earning assets
interest sensitive gap management
require management to perform an analysis of the maturities and repricing opportunities associated with interest bearing assets and interest bearing liabilities
positive gap
asset sensitive
negative gap
liability sensitive
negative gap (interest rate change effect)
in general, financial institutions with a negative cumulative gap will benefit form falling interest rates, but lose net interest income when interest rates rise
positive gap (interest rate change effect)
institutions with a positive cumulative gap will benefit if interest rates rise, but lose net interest income if market interest rates decline
aggressive gap management
when financial firms shade their interest-sensitive gaps toward either asset sensitivity or liability sensitivity, depending on their degree of confidence in their own interest rate forecasts
duration gap managemetn
managing duration
duration
a value and time-weighted measure of maturity that considers the timing of all cash inflows from earning assets and all cash outflows associated with liabilities
Convexity
the relationship between an asset’s change in price and its change in yield or interest rate that is related to duration
duration gap
the gap between the weighted average asset duration and the weighted average liability duration
portfolio immunization
when the duration gap = 0