Hedging interest rate risk in banking

✍ Scribed by Dr. David R. Goldfarb

• Book ID: 102843895
• Publisher: John Wiley and Sons
• Year: 1987
• Tongue: English
• Weight: 806 KB
• Volume: 7
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990070105

✦ Synopsis

T mediary that hedges its interest rate risk in the futures market. This interest rate risk has two components: asymmetric risk in the form of prepayment risk on fixed rate loans or through a cap feature on variable rate loans; and, symmetric risk in the form of interest rate level-risk and interest rate margin-risk. The implications of a loan generation fee are also incorporated into the analysis.

Futures markets are found to have a viable role in hedging interest rate risk when one of the components is asymmetric, provided the financial intermediary hedges its total assedliability imbalance. The intermediary will purchase (sell) more (fewer) futures contracts in the face of prepayment risk than when it does not consider this risk. When it issues variable rate loans with a cap it will, in general, purchase (sell) fewer (more) futures contracts than when issuing variable rate loans without this feature. personnel (Rose, 1981 andBooth, Smith and Stoltz, 1984) and institutional limitations (as market to the market) (Leeds, 1982).