INTEREST RATE RISK
MANAGEMENT
GROUP IV:
LAMOSTE, BRIEZA LIN P.
LUBRICO, MARYCRIS
ARAÑA, JESSA
COSIDO, RESIAN D.
INTEREST RATE SENSITIVITY
- The Impact of Interest Rate Fluctuations on a
company's financial performance
• Borrowing Costs: Rising interest rates
increase the cost of borrowing for companies,
impacting their profitability. This can lead to
reduced investment, slower growth, and
potentially lower stock prices.
• Investment Returns: Fluctuations in interest
rates affect the returns on fixed-income
investments, such as bonds. When interest rates
rise, the value of existing bonds falls, leading to
potential losses for companies holding such
assets.
• Cash Flow Management: Interest rate changes
can impact a company's ability to manage its cash
flow. For example, if a company has a large
amount of debt with variable interest rates, a rise
in interest rates could lead to a significant
increase in its debt servicing costs.
• Identifying Interest Rate Risk Exposures
- Companies must carefully identify their
interest rate risk exposures to develop effective
management strategies.
• Debt Structure: Analyze the company's debt
portfolio, including the types of debt (fixed or
variable interest rates), maturity dates, and
interest rate sensitivity
• Investment Portfolio: Evaluate the company's
fixed-income investments, considering their
maturity dates, coupon rates, and sensitivity to
interest rate changes.
• Operating Environment: Assess the
company's industry and its exposure to interest
rate-sensitive factors, such as borrowing costs,
customer demand, and input prices.
INTEREST RATE
DERIVATIVES:
Powerful Tools for
Management
- Derivatives are financial instruments whose
value is derived from the price of an
underlying asset. In the context of interest rate
risk management, derivatives can be used to
hedge against potential losses or speculate on
future interest rate movements.
• Interest Rate Swaps: A swap is an agreement
between two parties to exchange interest rate
payments on a notional principal amount. One
party pays a fixed interest rate while the other
pays a variable rate. This allows companies to
convert fixed-rate debt to variable-rate debt or
vice versa, depending on their risk profile.
• Interest Rate Futures: Futures contracts obligate
the buyer to purchase or the seller to sell a
specific asset at a predetermined price on a future
date. Interest rate futures allow companies to lock
in future interest rates, mitigating the risk of
rising rates.
• Interest Rate Options: Options give the buyer
the right, but not the obligation, to buy or sell
an underlying asset at a predetermined price
within a specific time frame. Interest rate
options allow companies to limit their
exposure to interest rate fluctuations while
retaining the potential for upside gains.
• Caps: An interest rate cap sets a maximum
interest rate, protecting borrowers from rising
rates.
• Floors: An interest rate floor sets a minimum
interest rate, protecting lenders from falling
rates.
• Collars: A collar combines a cap and a floor,
limiting both upside and downside risk.
MANAGING
INTEREST RATE RISK:
Strategies and
Techniques
• Hedging Strategies - Using derivatives, such
as swaps, futures, and options, companies can
hedge against potential losses from adverse
interest rate movements. This involves taking a
position in the derivatives market that offsets
the company's exposure to interest rate risk
•Asset-Liability Management (ALM) -ALM
involves matching the maturity dates and
interest rate sensitivity of a company's assets
and liabilities. This helps to minimize the
impact of interest rate fluctuations on the
company's net interest margin
• Duration Management: Duration is a
measure of a bond's price sensitivity to interest
rate changes. Companies can manage their
interest rate risk by adjusting the duration of
their bond portfolio
• Diversification: Spreading investments across
different asset classes and maturities can help
reduce overall interest rate risk
THANK YOU!
What is credit risk management ?
refers to the process of assessing, monitoring,
and mitigating the potential risk of a borrower
failing to repay a loan, encompassing activities
like evaluating a customer's creditworthiness,
utilizing credit scoring models, implementing
risk mitigation strategies like credit insurance,
and maintaining strict credit policies to control
overall credit risk exposure.
Credit Analysis and Assessment:
Evaluating Creditworthiness
Analyzing a customer's financial
history, income stability, employment
status, and other relevant factors to
determine their ability to repay debt.
What are Credit Scoring Models?
Credit scoring models are statistical tools
used by lenders and credit bureaus to
evaluate the creditworthiness of
individuals and businesses. These models
analyze various factors related to a
borrower's financial history and behavior
to predict the likelihood of them
defaulting on their debt obligations.
How Credit Scoring Models Work?
.
Credit scoring models use algorithms to assign a numerical
score based on a borrower's credit history. The score
typically ranges from 300 to 850, with a higher score
indicating a lower risk of default.
Factors considered by these models include:
Payment history: This is the most important factor,
reflecting a borrower's consistency in making payments
on time.
Credit utilization: This assesses how much of their
available credit a borrower is using.
Length of credit history: Lenders prefer borrowers with a
longer history of responsible credit use.
What is risk rating systems?
A risk rating system is a structured
approach for evaluating and classifying
risks based on their potential impact
and likelihood of occurrence. It helps
organizations prioritize risks, allocate
resources effectively, and develop
mitigation strategies.
Key Components of a Risk Rating System:
1.Risk Identification: The process of identifying potential
risks that could affect an organization's operations, objectives,
or reputation. This involves analyzing various aspects,
including financial, operational, strategic, and external factors.
2.Risk Assessment: Evaluating the likelihood of each
identified risk occurring and its potential impact on the
organization. This typically involves using a scale to quantify
both likelihood and impact.
3.Risk Rating: Assigning a numerical score or rating to each
risk based on its likelihood and impact. This score helps
prioritize risks and determine the level of attention and
resources required for mitigation.
4.Risk Categorization: Grouping risks into pre-
determined categories based on their overall risk rating.
Common categories include low, medium, and high
risk.
5.Risk Mitigation: Developing and implementing
strategies to reduce the likelihood or impact of
identified risks. This may involve preventive measures,
contingency plans, or risk transfer through insurance.
6.Monitoring and Review: Regularly reviewing and
updating risk ratings to ensure they remain accurate
and relevant. This involves considering new data,
changes in the operating environment, and the
effectiveness of implemented controls
Benefits of Using a Risk Rating System
1.Enhanced Decision-Making: Provides a quantifiable measure
of risk, enabling informed decisions about resource allocation
and mitigation strategies.
2.Proactive Risk Management: Facilitates early identification
and assessment of risks, allowing for proactive mitigation efforts.
3.Efficient Resource Allocation: Prioritizes risks based on
their severity, ensuring resources are directed towards the most
critical threats.
4.Improved Stakeholder Confidence: Demonstrates a
commitment to transparency and responsible risk management,
building trust with stakeholders.
5.Regulatory Compliance: Helps organizations comply with
regulatory requirements by systematically identifying and
addressing risks that could lead to breaches.
:
What is credit risk mitigation?
Credit risk mitigation refers to strategies
and techniques used by lenders or
financial institutions to reduce the risk of
financial loss from borrowers who may
fail to repay their loans. It involves
actions to protect the lender from the
potential of defaults or non-payment.
Here are common methods of credit risk mitigation:
•Credit Insurance:
Purchasing insurance to cover potential losses from a
borrower's default, providing protection to the lender.
•Letters of Credit:
A guarantee issued by a bank on behalf of a buyer, ensuring
payment to the seller even if the buyer defaults.
•Factoring:
Selling outstanding receivables to a third-party factoring
company at a discounted rate to generate immediate cash flow
•Credit Derivatives:
Financial instruments used to transfer credit risk to another
party, allowing for risk diversification
Managing Credit Risk:
Credit Policies and Procedures:
Establishing clear guidelines for
credit granting, including maximum
loan amounts, acceptable debt -to-
income ratios, and collateral
requirements.
One notable example is Security Bank's
Home Loan program.
Eligibility Criteria:
Applicants must be at least 21 years old but not more
than 65 years old upon loan maturity.
A combined monthly income of PHP 50,000 is
required.
Continuous employment for at least 2 years is
necessary.
For the self-employed, must be operating a legitimate
and profitable business for the last 3 years
Collateral document requirements:
Copy of collateral title , Transfer Certificate of Title
(TCT/CTC)
Copy of Tax Declaration on land and/or improvement
Appraisal Fee paid to SBC: OR Number_____
Monitoring and Controlling Credit Risk
Regularly reviewing credit exposures, identifying
potential problem loans, and taking corrective actions
as needed.
A good example of monitoring and controlling credit risk
in the Philippines is BDO unibank.
BDO regularly reviews its loans using a Risk Rating
System to assess the ability of borrowers to repay. If they
notice any potential issues with a loan (for example, if
the borrower is struggling to repay), they take corrective
actions like adjusting the loan terms or seizing the
collateral provided by the borrower.
