Financial analysts » debt

Accumulation Phase

admin — Sun, 14 Nov 2010 15:32:57 +0000

Individuals in the early-to-middle years of their working careers are in the accumulation phase. As the name implies, these individuals are attempting to accumulate assets to satisfy fairly immediate needs (for example, a down payment for a house) or longer-term goals (children’s college education, retirement). Typically, their net worth is small, and debt from car loans or their own past college loans may be heavy. As a result of their typically long investment time horizon and their future earning ability, individuals in the accumulation phase are willing to make relatively high-risk investments in the hopes of making above- average nominal returns over time.

Long-term Positions

admin — Sun, 15 Nov 2009 08:55:02 +0000

Positions that are of longer term are more often hedged through swap markets than forward markets. The structure of a foreign currency swap is very similar to that of a floating rate interest rate swap. We will take the case of a floating rate ¥1000bn five-year loan with interest paid every three months. In order to hedge the annual interest payments we would enter into a yen–dollar swap agreement with terms as follows: Nominal values of the contracts are ¥1000bn and $1bn. The amount to be paid by the yen payer is set at the current spot yen 90-day interest rate for settlement 90 days after.
The amount to be paid by the US$ payer is set at the current US$ 90 day interest rate for payment 90–days after.
Interest rate parity ensures that the US-based bank has fully hedged the interest payments due from the loan. (This is a simplified example and in practice we would have to look more fully at the pricing basis and payment terms of the loan and take these into account.)
The following, slightly more complex, worked example is of a three-year euro–yen swap. The conditions of the two parties are as follows:
Nominal value. Nominal values of the contracts are ¥500bn and €600m.
Payment calculation. Interest to be calculated on a quarterly basis. Payments by the yen payer are to be based on the spot yen 90-day London interbank rate plus 150 bpts and at the spot euro LIBOR for the euro payer. On the day that the agreement starts the two payments due are calculated based on 90-day yen rates of 0.75% and euro rates of 2.25%, giving payments due of ¥281.250m nd €3.375m.
Settlement. Settlement is to be made 90 days after the date of calculation on a netted basis in US$. The calculated payments are converted into US$ based on the then yen:US$ spot rate of 99.50 and a euro:US$ spot rate of 1.205. The yen payment due is US$2 826 633 while that of the euro payer is $2 800 830. The yen payer pays the difference of US$25 803 to the yen receiver.

GAP ANALYSIS

admin — Fri, 02 Oct 2009 08:53:11 +0000

In many countries banks are required to disclose their period-end interest rate gap positions in the form of the following report. These reports show balance sheet assets and liabilities broken down by when they are next due for repricing. The effects of off-balance sheet items such as swaps are also included within the summary.
A positive interest rate gap means that more assets than liabilities are due to be repriced in a particular time interval. The following bank has a negative yield gap over the next 12 months and as such net interest margins should benefit from falling interest rates.
This would suggest that we can quantify the impact of rate changes within a specific time interval. The impact of an increase in short-term rates for a specific interval is given in general by:
Impact on net interest income = Balance sheet gap for time interval × àr For the three-month or less time interval for a 100 bpt increase in rates would imply:
Impact on net interest income = ?($7500m × 0.01) = ?$75m
Concentrating on managing short-term interest rate gaps can help banks report relatively stable spreads but this may have the effect of ignoring duration gaps for assets and liabilities with long duration. This will lead to increased risks of losses in economic value.
In practice analysts do not find gap reports of much use for a number of reasons:
They represent a snapshot in time and by the time they are released are usually well out of date. They indicate how a bank was positioning itself for changing interest rates rather than what they are now expecting. The use of the off-balance sheet instruments allows banks to adjust their gap positions in the medium and long term relatively quickly. They do not take any account of embedded options whether explicit as with mortgage pre- payments, or implicit options that exist in many deposits. If interest rates rise some demand deposit holders will exercise their option to withdraw their funds and redeposit them in an interest-bearing account. The time intervals are generally very broad and banks do not report an average repricing period. An analyst usually makes simplifying assumptions, for example that all deposits in the three to six-month time frame are repriced after four and a half months. Interest rates can remain stable for a protracted period but at times may change on a regular basis over a period of many months. It becomes increasingly difficult to estimate the potential impact of multiple interest rate changes on repricing. Rates across the yield curve do not usually change in parallel.
Banks are not passive observers. When interest rates are falling they will try to cut borrowing rates more than they cut lending rates. Lending rates are generally relatively sticky in a falling interest rate environment.