Asset Liability Management Crash Course – Detailed Course Description

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1. Course Content

1. INTRODUCTION Interest Rate Risk Liquidity Risk 2. DURATION AND CONVEXITY Duration a. Macaulay Duration b. Modified Duration Convexity Approximate price change Terminology: Modified and Effective 3. VALUE AT RISK (VAR) Variance Covariance Approach a. Determining SMA volatility b. Determining EWMA Volatility c. Determining SMA and EWMA daily VaR Historical Simulation Method a. Determining Historical Simulation daily VaR b. Scaling of the daily VaR 4. ALM RISK MEASUREMENT TOOLS Fall in Market Value of Equity Step 1: Determine look back period Step 2: Data collection Step 3: Calculated the return series Step 4: Calculate the days to maturity/ days to reset Step 5: Calculate individual weights for each asset and liability Step 6: Obtain return series for each individual asset/ liability Step 7: Calculate weighted average return series for assets and liabilities separately Step 8: Compute VaR Step 9: Compute the MTM weighted average yield to maturity (YTM) Step 10: Compute Rate Shock Step 11: Compute the weighted duration of assets and liabilities Step 12: Fall in MVE Earnings at Risk Step 1: Determine look back period Step 2: Data collection Step 3: Calculated the return series Step 4: Identify assets, liabilities & off balance sheet (OBS) instruments to be included in the calculation Step 5: Calculated expected cash flows and days to maturity (DTM) Step 6: Slot the cash flows according to DTM Step 7: Compute weights of each sub bucket with respect to overall bucket Step 8: Compute correlated return series based on the weights calculated in Step 7 above Step 9: Compute rate VaR Step 10: Compute Rate Shift/ Shock Step 11: Compute the change in rate sensitive assets/ liabilities/ off- balance sheet items Step 12: Compute the on-balance sheet and cumulative gaps for each defined bucket Step 13: Compute total EAR for the given confidence level Cost to Close Interest Rate Risk Liquidity Risk Rate Sensitive Gap Step 1: Define the time buckets Step 2: Classification of on- and off- balance sheet items Step 3: Slot items into relevant time buckets Step 4: Calculate rate sensitive gap Step 5: Calculate off-balance sheet gap Step 6: Calculated interval gap Step 7: Calculate cumulative gap Price Sensitive Gap Liquidity Gap Net Interest Income (NII) at Risk Duration Gap Analysis 5. APPLICATIONS Bank Duration matching/ immunization Pension Funds and Insurance Portfolio dedication 6. OTHER LIQUIDITY RISK MEASUREMENT TOOLS Liquidity Ratios and Analysis Current Ratio Quick Ratio Unused lines of credit Borrowing/ Debt-to-Equity Ratio Net Working Capital Ratio Loan-to-Deposit Ratio Loan- to- Asset Ratio 7. LIQUIDITY MANAGEMENT Setting limits for liquidity risk Cash flow mismatch or gap limits Maturity Limits Target Liquid Reserves Concentration Limits Contingent liability limit Review Exception handling Contingency Funding Plan General requirements for a liquidity contingency plan Specific requirements for a liquidity contingency plan Liquidity enhancement tactics For Systemic crisis For company specific crisis

EXCEL Examples Yes – Available for sale The example includes 4 Excel files that cover each of the following concepts: Fall in the Market Value of Equity Earnings at Risk Cost to Close – Interest Rate Risk perspective Cost to Close – Liquidity Risk perspective

2. Introduction Asset Liability Management (ALM) involves taking decisions and actions regarding assets and liabilities in an integrated manner in order to manage the business of the entity and meet the organization’s financial objectives. It is a continuing process that involves formulating, implementing, monitoring and revising strategies related to its assets and liabilities keeping in mind the entity’s risk tolerances and constraints. ALM is an essential and critical process for any organization that invests to meet its future cash flow needs and capital requirements. The traditional application of ALM primarily dealt with managing risks associated with interest rate changes. But today ALM has a much wider focus encompassing equity risk, liquidity risk, legal risk, currency risk and sovereign or country risk. In this study note we will look primarily at interest rate risk (in particular interest rate mismatch risk) and liquidity risk.

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