Repricing Model

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Interest Rate Risk Management


The Repricing Model

A simple balance sheet has been classified for a 6 month maturity bucket below: Assets
Rate Sensitive Assets
(RSAs)
Fixed Rate Assets
(FRAs)
Nonearning Assets
(NEAs)
Total

$100
$200

Liabilities
Rate Sensitive Liabilities
(RSLs)
Fixed Rate Liabilities
(FRLs)

$ 50
$250

$ 40

Equity

$ 40

$340

Total

$340

1. Classify each asset on the balance sheet as either:
RSA
FRA
NEA
2. Classify each liability/equity account:
RSL
FRL
Equity
3. Group assets and liabilities into the following groups:
RSAs financed by RSLs
FRAs financed by FRLs
NEA financed by Equity
Gap: Positive dollar RS Gap: Indicates that excess RSAs financed by remaining FRLs Negative dollar
RS Gap: Excess FRAs financed by remaining RSLs
The leftovers:
Whatever is leftover financed by equity OR Equity financing whatever is leftover This analysis highlights the idea that the quantity of interest rate risk depends upon the size of the gap. 4. Calculate the average annual % rate of return on each asset category and the average annual % cost rate on each liability category and then calculate the spreads. Spreads are the difference between the income rate and the cost rate per dollar invested in the category.

5. Calculate the dollar contribution to profit from each category as the product of the amount times the spread. 6. Add up the profits. The banker is now in a position to both understand the major sources of profitability and compare pricing with other institutions. One can also easily forecast changes in profitability for various projected changes in interest rates.

Cumulative GAP and Spread Effects:
Dollar GAP
Spread Effect
R
Direction of NII
Positive
Positive
Increase
Increase
Negative
Increase
Ambiguous
Positive
Decrease
Ambiguous
Negative
Decrease
Decrease
Negative

Positive
Negative
Positive
Negative

Increase
Increase
Decrease
Decrease

Ambiguous
Decrease
Increase
Ambiguous

A more detailed example of the repricing model for a 1 year maturity bucket. Assets ($ Mill)
Investments under 1 year
$ 100
@ 5%
Loans < 1 year @ 7%
Variable rate loans
(rate reset in 6 months) @
6.5%
Fixed Rate Assets > 1
year maturity @ 8%
Total

Liabilities & Equity
Deposits < 1 year @ 4%

$ 900

$ 350

All Long Term Liabilities
@ 7%

$ 500

$ 300

Equity

$ 200

Total

$1,600

$ 850
$1,600

Assets ($ Mill)
Investments under 1 year
$ 100
@ 5%
Loans < 1 year @ 7%
Variable rate loans
(rate reset in 6 months) @
6.5%
Fixed Rate Assets > 1
year maturity @ 8%
Total

Liabilities & Equity
Deposits < 1 year @ 4%

$ 900

$ 350

All Long Term Liabilities
@ 7%

$ 500

$ 300

Equity

$ 200

Total

$1,600

$ 850
$1,600

All assets and liabilities that mature in less than one year or have an interest rate reset within one year are potentially rate sensitive.
Rearranging the assets and liabilities into the appropriate sensitivity categories based on maturity and payment pattern results gives the following results:
Rate Sensitive Assets
Rate Sensitive Liabilities
Amnt
Income
Amnt
Cost
Investments
Deposits < 1
under 1 year @
$ 100
$ 5.00
year @ 4%
$ 900
$ 36.00
5%
Loans < 1 year
$ 350
$24.50
@ 7%
Variable rate
loans
(rate reset in 6
$ 300
$19.50
months) @
6.5%
Total RSAs
$ 750
Total
$ 900
Total Income
$49.00
Total Cost
$ 36.00
NII from this
$13.00
category
Average rate of
Average cost
6.533%
4.000%
return
rate
Spread on RSAs financed by RSLs
2.533%
(6.533% - 4%)
The spread indicates the contribution to profit from this category per dollar invested (ignoring noninterest income and costs.) Note that some RSLs are used to finance something other than RSAs since there are only $750 RSAs but $900 RSLs.

The negative dollar gap indicates that some fixed rate
Dollar Gap = RSAs – RSLs = -$ 150
assets are financed by rate sensitive liabilities.
Percentage Gap =...
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