Models for Interest Rate Risk Essay

Interest risk is the possibility of unexpected adverse changes in following revenues and expenses. It can be shown that vex rate changes are temporary almost 100%. They depend on monetary policy translate and demand, inflation etc. These in turn depend on galore(postnominal) other factors. So how do financial institutions manage the risk of move sideline rates give that they cannot predict it? The immunization of a portfolio against interest rate risk means that the portfolio will neither gain nor fall behind value if interest rates change.In this essay we will verbal expression at some of the different models used by financial institutions for managing interest rate risk. They are the re-pricing model, the adulthood model and the duration model. We will make them and evaluate the comparative advantages and disadvantages separately model assumes. Firstly we consider the re-pricing model. It is a balance sheet where assets and liabilities are grouped according to the time periods in which the different assets and liabilities are rate medium.Assets or liabilities are rate sensitive within a given time period if the values of each are subject to receiving a different interest rate should market place rates change. These groupings are referred to as maturity buckets. Then Gap summary is conducted where the rate sensitive liabilities are subtracted from rate sensitive assets for each maturity bucket. This is called the GAP. It can be shown that GAP * interest change = net interest income (or profit) change or the interest margin. We can also calculate the cumulative gap(CGAP) by adding up the gaps in the brackets over a period of time, for shell 1 year.