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Betas – An Unintended Consequence of Simplifying Pricing Assumptions

Non-maturity deposits (NMDs) and their treatment in A/LM modeling is often a hot-button topic with examiners and management teams.  While there are key risk characteristics of NMDs not addressed with many methodologies (see previous blog entries below), the topic of this blog concerns NMD pricing assumptions. Blog:  Isolating Interest Rate Risk with a Static Balance […]

Evaluating Derivatives―Part III: Economic Value as Rates Change Instantly

This blog will begin to review the economic value of a swap when testing an instantaneous rate change. This builds on the blog Evaluating Derivatives—Part II:  Economic Value.  As before, the example swap has the following terms: 7-year term Notional amount: $100 million Credit union pays fixed rate of 2.00% Credit union receives 3-month LIBOR […]

Why Are My Income Simulation Results so Strong in a Shock?

In performing model validations for credit unions, we often see income simulation results that show significant improvement in net interest income (NII) and net income (NI) as rates rise, even for credit unions that have material positions in long-term, fixed-rate assets.  Why does this happen, and is it reasonable? Income simulations are commonly run with […]

Risk/Return Trade-Off—Part II

In last week’s blog, we discussed the need to understand risk/return trade-offs and the concern in relying solely on net economic value (NEV) for decision-making. If the objective is to decrease NEV volatility and your strategy under consideration is to A) Sell 30-year mortgages or B) Sell a 3-year bullet, does NEV fairly represent the […]

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