3.3marketriskmgmt
3.3marketriskmgmt
3.3marketriskmgmt
ALM Management
- analyse -> approach -> hedge -> report
- emphasis is placed on interest rate risks
- ALM=optimization of an institutions financial resources (balance sheet management)
- highly important for banks as b/s are predominantly financial+highly leveraged
- banks have more sophisticated ALM methodologies. but it is relevant for all institutions
Value or income (Kantonal- Raiffeisenbanken)
income driven (Jahresgewinn um 1% erhöht)
Bilanzsumme stieg 9%
EK + 5.5%
margins sinken -> volumes rauf, growth against margin decrease
income vs value effect findings
- Risks appear opposite
- assets values grow when rates decline, while income suffers
- Solution: Net effect = total return
- Evidence: real estate boom due to low rates
- asset repricing slower than liabilities
Interest rate risks
Curve risk (curves change)
Basis risk (differentials move)
Repricing risk (roll-over risk)
Option risk (open or embedded)
Model risk (false theories)
Learnings Value vs income effect
- Effect on one single bond (MTM) are opposed
- Balance sheets are a combination of long bond and short bond
- A > L: Temporary positive as long as rates fall. However, in the long
run, low interest rates are bad, as it presses margins and returns on
invested equity
- A < L: Good as soon as rates rise. However, costly if rates curve is
positively sloped
Significance for ALM
- Be aware of accounting. Internal and external reporting may vary!
- Where is your bonus based on? What do analysts monitor?
- Academics love value effects, but practice is largely accrual
- risk is not yet regulated -> free risk!
a
Trading book
a
Internally bond funding
- Fund 90% short-term (because it is a liquid trading asset)
- Fund 10% long-term (because it is not fully liquid)
- Be aware that haircuts can vary
Well-managed universal banks differentiate - Libor-based FTP for the traditional banking business - Bond-based FTP for the investment banking business
Learnings banking vs. trading book
ALM is value chain management
- ALM is focusing on the banking book value chain. The banking book
covers the traditional bank transformation function
- If a bank has significant trading acti
vities: separate trading book (VaR)
- The trading book resides outside the ALM focus
Significance for ALM
- Interactions between banking book and trading book:
- Haircut funding (10% or 30%?)
- Transfer pricing (the IB cash curve is on a higher level)
- Access to external markets (only one book per product
Example bank balance sheet
- Integrated (universal) bank
- Reverse Repo / Repo: Repurchasement agreement, A sells B securities with obligation to buy them (same type/quantity) back at day x for price y. Money Market instrument, short term capital raise
- replacement values: Market value of derivative transactions
- CDS: The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product.
- The majority of the positions are liquid, and have short durations to maturity
Two methods of risk transfer
“At contractual terms”
- A position matures at its next re-pricing date:
- New 5y fix-rate-mortgage re-prices after 5y -> into 5y time bucket
- 5y mortgage, originated 2 years ago -> into the 3y time bucket
- Libor-mortgage, referenced to 3-m-Libor -> 3m time bucket
“Replicated”
- Positions without formal re-pricing date
- Reset at management’s discretion (theoretically overnight). In practice, they follow competitors
- An assumed re-pricing pattern has to be modeled
- Thus, ALM translates uncertainty into manageability, by creating a rolling portfolio of transactions. Idea: Average of all transactions we will be right
- Example: 16.6% 1 month; 33% 2 months; 50% 3 months
Maturity profile & avarage pofo rate
Findings - The maturity is based on residual maturities (not original) - The average rate is based on original rates (legacy rates)
Replication exercise
Assume a replication strategy on CHF 1.2bn client deposits as follows: 50% 3 months and 50% 6 months, monthly rollovers
- Average remaining maturity? 2.75 months - Estimate the portfolio duration est. 2 months
Advantages of replication
- Approximates market risk, as it sets a benchmark - Replicated portfolio rate allows for FTP and margin calculation - Ease of use: easier to value the RPF than the underlying products - Can be applied in day-to-day treasury processes - The term structure of interest rates is automatically taken into account - If duration is longer than overnight, allows yield pick-up on investments
Volume risks (replication exercise)
What happens, if clients withdrew CHF 600m in 1 month time?
Evidence: In 2008 UBS lost CHF 80bn client deposits (25% of all). These losses could be fully funded out of maturing replication tranches. I.e. there was no particular market funding necessary
Replication learnings
Replication
- Describes the (assumed) client rate behavior by a mix of tenors
- Maintains a portfolio of internal transactions -> creates duration and rate
- Creates a basis for risk management & earnings allocation
Significance for ALM
- Model risk! (see part II)
- Impact on product profitability
- Parameter become not only part of the risk discussion, but also part of product management (thus quite strategic)
Data gathering for the banking book
- Which volumes feed the bank book position? -> Bank book positions: loans, deposits, fixed assets, bonds, equity (blue positions). Predominantly accrual accounting.
- At which transfer price are these positions transferred? -> FTP is linked to Libor
- What basic methods exist to transfer these positions? -> Risk transfer is either Contractual or Replicated
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Lernkarten
ALM Management
- analyse -> approach -> hedge -> report
- emphasis is placed on interest rate risks
- ALM=optimization of an institutions financial resources (balance sheet management)
- highly important for banks as b/s are predominantly financial+highly leveraged
- banks have more sophisticated ALM methodologies. but it is relevant for all institutions
Value or income (Kantonal- Raiffeisenbanken)
income driven (Jahresgewinn um 1% erhöht)
Bilanzsumme stieg 9%
EK + 5.5%
margins sinken -> volumes rauf, growth against margin decrease
income vs value effect findings
- Risks appear opposite
- assets values grow when rates decline, while income suffers
- Solution: Net effect = total return
- Evidence: real estate boom due to low rates
- asset repricing slower than liabilities
Interest rate risks
Curve risk (curves change)
Basis risk (differentials move)
Repricing risk (roll-over risk)
Option risk (open or embedded)
Model risk (false theories)
Learnings Value vs income effect
- Effect on one single bond (MTM) are opposed
- Balance sheets are a combination of long bond and short bond
- A > L: Temporary positive as long as rates fall. However, in the long
run, low interest rates are bad, as it presses margins and returns on
invested equity
- A < L: Good as soon as rates rise. However, costly if rates curve is
positively sloped
Significance for ALM
- Be aware of accounting. Internal and external reporting may vary!
- Where is your bonus based on? What do analysts monitor?
- Academics love value effects, but practice is largely accrual
- risk is not yet regulated -> free risk!
a
Trading book
a
Internally bond funding
- Fund 90% short-term (because it is a liquid trading asset)
- Fund 10% long-term (because it is not fully liquid)
- Be aware that haircuts can vary
Well-managed universal banks differentiate - Libor-based FTP for the traditional banking business - Bond-based FTP for the investment banking business
Learnings banking vs. trading book
ALM is value chain management
- ALM is focusing on the banking book value chain. The banking book
covers the traditional bank transformation function
- If a bank has significant trading acti
vities: separate trading book (VaR)
- The trading book resides outside the ALM focus
Significance for ALM
- Interactions between banking book and trading book:
- Haircut funding (10% or 30%?)
- Transfer pricing (the IB cash curve is on a higher level)
- Access to external markets (only one book per product
Example bank balance sheet
- Integrated (universal) bank
- Reverse Repo / Repo: Repurchasement agreement, A sells B securities with obligation to buy them (same type/quantity) back at day x for price y. Money Market instrument, short term capital raise
- replacement values: Market value of derivative transactions
- CDS: The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product.
- The majority of the positions are liquid, and have short durations to maturity
Two methods of risk transfer
“At contractual terms”
- A position matures at its next re-pricing date:
- New 5y fix-rate-mortgage re-prices after 5y -> into 5y time bucket
- 5y mortgage, originated 2 years ago -> into the 3y time bucket
- Libor-mortgage, referenced to 3-m-Libor -> 3m time bucket
“Replicated”
- Positions without formal re-pricing date
- Reset at management’s discretion (theoretically overnight). In practice, they follow competitors
- An assumed re-pricing pattern has to be modeled
- Thus, ALM translates uncertainty into manageability, by creating a rolling portfolio of transactions. Idea: Average of all transactions we will be right
- Example: 16.6% 1 month; 33% 2 months; 50% 3 months
Maturity profile & avarage pofo rate
Findings - The maturity is based on residual maturities (not original) - The average rate is based on original rates (legacy rates)
Replication exercise
Assume a replication strategy on CHF 1.2bn client deposits as follows: 50% 3 months and 50% 6 months, monthly rollovers
- Average remaining maturity? 2.75 months - Estimate the portfolio duration est. 2 months
Advantages of replication
- Approximates market risk, as it sets a benchmark - Replicated portfolio rate allows for FTP and margin calculation - Ease of use: easier to value the RPF than the underlying products - Can be applied in day-to-day treasury processes - The term structure of interest rates is automatically taken into account - If duration is longer than overnight, allows yield pick-up on investments
Volume risks (replication exercise)
What happens, if clients withdrew CHF 600m in 1 month time?
Evidence: In 2008 UBS lost CHF 80bn client deposits (25% of all). These losses could be fully funded out of maturing replication tranches. I.e. there was no particular market funding necessary
Replication learnings
Replication
- Describes the (assumed) client rate behavior by a mix of tenors
- Maintains a portfolio of internal transactions -> creates duration and rate
- Creates a basis for risk management & earnings allocation
Significance for ALM
- Model risk! (see part II)
- Impact on product profitability
- Parameter become not only part of the risk discussion, but also part of product management (thus quite strategic)
Data gathering for the banking book
- Which volumes feed the bank book position? -> Bank book positions: loans, deposits, fixed assets, bonds, equity (blue positions). Predominantly accrual accounting.
- At which transfer price are these positions transferred? -> FTP is linked to Libor
- What basic methods exist to transfer these positions? -> Risk transfer is either Contractual or Replicated
