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Interest/Maturity Gap and Sensitivity

This article delves into the concepts of Interest and Maturity Gaps, including their significance in managing on- and off-balance sheet assets and liabilities. It explains the impact of economic cycles on interest rates, the mechanics of maturity patterns, and how managing rate-sensitive assets and liabilities can stabilize financial spreads. Moreover, it outlines the duration gap's role in assessing the potential changes in asset and liability values due to interest rate fluctuations. This information is vital for effective financial strategy formulation and risk management.

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Interest/Maturity Gap and Sensitivity

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  1. Interest/Maturity GapandSensitivity

  2. Interest/Maturity Gap • G & K Chp. 5 • Why Gap? Manage on- or off-balance sheet • Off-Balance Sheet (Futures, Options, later….) • Economic Environment • Maturity Gap • Duration Gap

  3. Why Gap? • Maturity Pattern and Interest Rate Sensitivity of Assets and Liabilities differ. • Fixed Rate Investment funded by Floating Rates can create Spread Squeezes. • Want to create stable Spread, and force maximum funds through…… • Changes in interest rates compound spread management by imparting value management in addition.

  4. Business Cycle and Interest Rates • Trough: Low economic activity; low demand for funds, high demand for safe, liquid investments  Low relative rates, + - curve • Growth to Peak: Increasing economic activity; high demand for funds, low demand for interest-rate investments  Higher relative rates, + - to – flattening curve • SlowdownTrough; Slowing economic activity, early high demand for funds gives rise to drop off  High rates drop, with inverted-curve returning to positive slope

  5. Maturity Gap • Repricing of Book Values of Assets vs. Liabilities in common time periods • Pg. 5 of any output • Rate Sensitive Assets (RSAs) and Rate Sensitive Liabilities (RSLs) • 3, 6, 9 mo., 1 yr., 1-3 yrs., Over 3 yrs. • Idea is: (Gap = RSA – RSL) NII = Gap *  R

  6. Maturity Gap • Rates Go Up • Positive Gap  Increase NII • Negative Gap  Decrease NII • Rates Go Down • Positive Gap  Decrease NII • Negative Gap  Increase NII • Problems: • Ignores Market Value Changes • Ignores variation in intra-bucket value changes • Concentrates on single-period CF, not MV

  7. Maturity Gap • Y1Q4: • 3 month Assets: 3596.96 • 3 month Liabilities: 2617.51 • RSA – RSL = 3 month Gap = 979.45 • 3 month Interest Rates go up .25% • NII should jump (0.0025*979.45) $2.45 mill

  8. Duration Gap • Duration Weighted Assets and Liabilities • Managing the Change in Equity (Value) from a change in interest rates and their effect on Assets and Liabilities • Remember: Price = - D * r / (1 + YTM) * Price • Applied to Assets and Liabilities: A = - DA * R / (1 + R) * A L = - DL * R / (1 + R) * L

  9. Duration Gap • Then: E = A - L • E = -[ DA - DL (L/A)] * [R/(1+R)] * A Change in Equity is negative of difference in durations multiplied by interest rate change multiplied by asset base

  10. Duration Gap • Rates Go Up • Positive Duration Gap  Decrease Value • Negative Duration Gap  Increase Value • Rates Go Down • Positive Duration Gap  Increase Value • Negative Duration Gap  Decrease Value

  11. Duration Gap • From 1.4 Output: • Assets: Duration = 0.427 , Value = $4.897 bill • Liabs: Duration = 1.103, Value = $4.609 bill • Notice……Negatively Gapped! • Assume R=7% 7.05% E = -[ DA - DL (L/A)] * (R/(1+R) * A = -[.427 – 1.103 (4.609/4.897)]*(+.0005/1.07)*4.897 = +0.00139846 = +$ 1.39846 million

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