Interest rate risk
Interest rate risk is included in the larger category of market risk,to which a bank, like any financial institution, is subject to. A move inany such risk can result in profit or loss for the bank, but here we areinterested in the loss part, correlated with risk. As taken from the glossary on the Internet, interest rate risk can bedefined as "the possibility of a reduction in the value of a security,especially a bond, resulting from a rise in interest rates". However, inthe case of a bank, this definition can be somewhat diversified and thereare two aspects that we have to deal with. First, we may consider aportfolio of diversified assets, including bonds that the bank, as a playeron the financial market owns. As a security, these bonds have a two-facedvalue, one given by there face value and another given by their coupon. Ifthe interest rates on the market rise, than the bank that owns theportfolio of bonds will suffer a loss, because the earnings it will makefrom its portfolio will decrease (we are referring here to the simple caseof a fixed-coupon bond. If we take into consideration more complicatedforms of bonds, including bonds of variable coupon, that this no longer
These willbring a, let's say, $1,000,000 profit. A technique of managing interest rate risk that has been used forsome time now is the GAP technique or the GAP model. This type of risk arises fromform the repricings that may occur in the bank's assets and liabilities andmay happen to any of the operational units of a bank. That is, if the bank has loaned money for a period of 1 year at aninterest rate of 10 %, it can hedge its risk by adopting a differentposition on the future market, a position that assumes that the interestrate will rise. The second type of interest rate risk that a bank (hence HSBC) has todeal with is structural interest rate risk. As of 30th of June 2002, HSBC's interest rate tradingpositions accounted for $66. Thus, the GAP model takes intoconsideration the assets sensitive to interest rate risk and theliabilities sensitive to interest rate risk and calculates the differencebetween the two. In the case that the interest rate does rise, than it willmake a profit on the future market, while in the case that the interestrate decreases, it will earn with its loaning position. We have defined in this paper interest rate risk and severalfinancial methods of interest rate risk management, applied to HSBC. The risk management part appears with the condition GAP = 0, which isthe case when the bank wishes to hedge its income against changes in theinterest rate. As an official from Citibank said veryplastically, "if we don't gap, we can't make enough money". However, both methods usescenarios for the evaluation, the difference is in how those scenarios aregenerated. Let me detail a bit the simulation model technique. In this way, it is easier to adapt risk managementtechniques to a whole group of risks and, of course, fewer techniques willbe used.
Common topics in this essay:
Monte Carlo,
,
HSBC VAR,
Value-at-Risk VAR,
HSBC Report,
rate risk,
Value-at-Risk GAP,
managing rate risk,
rate rise,
10 %,
historical simulation,
managing rate,
risk management,
gap model,
future market,
rate risk liabilities,
monte carlo simulation,
bought bonds,
carlo simulation,
bank owns portfolio,
owns portfolio bonds,
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Acceptance Essays
