CH7 - Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques

Question 1

Define: Interest rate risk

Answer 1

refers to the volatility in net interest income attributable to changes in the
level of interest rates and shifts in the composition and volume of bank assets and liabilities

Question 2

Why is Asset and Liability Management (ALM) important?

Answer 2

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

Question 3

Define: Asset and Liability Management (ALM)

Answer 3

A managerial process to address the risk faced by banks due to the
mismatch between its assets and liabilities

Question 4

What does Asset and Liability Management (ALM) do?

Answer 4

Manages liquidity and interest rate risk
Help addresses capital adequacy
Assists the treasury department in liquidity and interest rate management process
Assist in hedging and compliance processes

Question 5

How does ALM assist in recommendation process regarding balance sheet actions?

Answer 5

Setting limits on the maximum size of major asset/liability categories;
Pricing of loans and deposits
Correlating maturities and terms

Question 6

What does ALM help with?

Answer 6

Helps to provide better cash flow and liquidity management and control over
NII, NIM and EVE over the long-run

Question 7

What are the two types of ALM frameworks?

Answer 7

Static
Dynamic

Question 8

Explain: Static

Answer 8

Identifying and managing current existing risks to maximizing profits

Question 9

Explain: Dynamic

Answer 9

Identifying and managing future events and to manage the mix of assets and liabilities

Question 10

What are the three strategies under ALM?

Answer 10

Asset Management Strategy
Liability Management Strategy
Funds Management strategy

Question 11

What is Asset Management Strategy?

Answer 11

control over assets, no control over liabilities

Question 12

What is Liability Management Strategy?

Answer 12

control over liabilities by changing rates and other terms

Question 13

What is Funds Management strategy?

Answer 13

work with both asset and liability management strategy

Question 14

What is the problem with managing the asset and liability side of a balance sheet?

Answer 14

Maturity Gap

Question 15

Define: Maturity Gap

Answer 15

The mismatch between assets and liabilities in terms of maturity

Question 16

What is the effect of interest rate movement?

Answer 16

Interest rate movements can influence revenues, costs, market
value of assets or liabilities and the net worth

Question 17

List 3 examples of Repriceable Assets

Answer 17

• Short-term securities issued by government and private borrowers (about to mature)
• Short-term loans made to borrowing customers (about to mature)
• Variable-rate loans and securities

Question 18

List 3 examples of Repriceable Liabilities

Answer 18

Borrowings from the money market
Short-term savings account
Money-market deposits

Question 19

List 3 examples of non-repriceable Liabilities

Answer 19

Demand deposits
Long-term savings and retirement accounts
Equity capital provided by the financial institutions owners

Question 20

List 4 examples of non-repriceable Assets

Answer 20

Cash in the vault and deposits at the Central Bank
Long-term loans made at a fixed interest rate
Long term securities carrying fixed rates
Buildings and Equipment

Question 21

What is interest rates?

Answer 21

The price of money
Opportunity costs for investing
The return on an investment

Question 22

List the two economic theories are used to determine interest rates

Answer 22

The liquidity preference theory
The loanable fund theory