3.3marketriskmgmt

income driven (Jahresgewinn um 1% erhöht)

Bilanzsumme stieg 9%

EK + 5.5%

margins sinken -> volumes rauf, growth against margin decrease

- 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

Curve risk (curves change)

Basis risk (differentials move)

Repricing risk (roll-over risk)

Option risk (open or embedded)

Model risk (false theories)

- 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

- 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!

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- 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

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

- 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

“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

Findings - The maturity is based on residual maturities (not original) - The average rate is based on original rates (legacy rates)

- Average remaining maturity? 2.75 months - Estimate the portfolio duration est. 2 months

- 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

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

- 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)

- 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