Bank Management,

Management 6th edition.

Timothy W. Koch and S. Scott MacDonald
Copyright © 2006 by South-Western, a division of Thomson Learning

Managing Interest Rate Risk:

Duration GAP and Economic Value
of Equity

Chapter 6

William Chittenden edited and updated the PowerPoint slides for this edition.
Measuring Interest Rate Risk with Duration
GAP
 Economic Value of Equity Analysis
 Focuses on changes in stockholders’
equity given potential changes in
interest rates
 Duration GAP Analysis
 Compares the price sensitivity of a
bank’s total assets with the price
sensitivity of its total liabilities to
assess the impact of potential changes
in interest rates on stockholders’
equity.
Recall from Chapter 4

 Duration is a measure of the effective

maturity of a security.
 Duration incorporates the timing and
size of a security’s cash flows.
 Duration measures how price sensitive
a security is to changes in interest
rates.
 The greater (shorter) the duration, the
greater (lesser) the price sensitivity.
Duration and Price Volatility
 Duration as an Elasticity Measure
 Duration versus Maturity
 Consider the cash flows for these two
securities over the following time line
0 5 10 15 20

$1,000
01 5 10 15 20

900 $100
Duration versus Maturity
 The maturity of both is 20 years
 Maturity does not account for the differences in
timing of the cash flows
 What is the effective maturity of both?
 The effective maturity of the first security is:
 (1,000/1,000) x 1 = 20 years
 The effective maturity of the second security is:
 [(900/1,000) x 1]+[(100/1,000) x 20] = 2.9 years
 Duration is similar, however, it uses a weighted
average of the present values of the cash flows
Duration versus Maturity

Duration is an approximate measure of

the price elasticity of demand

% Change in Quantity Demanded

Price Elasticity of Demand = -
% Change in Price
Duration versus Maturity

 The longer the duration, the larger the

change in price for a given change in
interest rates.
∆P
Duration ≅ - P
∆i
(1 + i)
 ∆i 
∆P ≅ - Duration P
 (1 + i) 
Measuring Duration

 Duration is a weighted average of the

time until the expected cash flows
from a security will be received,
relative to the security’s price
 Macaulay’s Duration
k n
CFt (t) CFt (t)
∑ (1 + r) t ∑ (1 + r) t
D = t=k1 = t =1
CFt Price of the Security
∑
t =1 (1 + r) t
Measuring Duration

 Example
 What is the duration of a bond with a
$1,000 face value, 10% annual coupon
payments, 3 years to maturity and a
12% YTM? The bond’s price is $951.96.

100 × 1 100 × 2 100 × 3 1,000 × 3

1
+ 2
+ 3
+
(1.12) (1.12) (1.12) (1.12)3 2,597.6
D= 3
= = 2.73 years
100 1000 951.96
∑t =1 (1.12) t
+
(1.12)3
 Measuring Duration

 Example
 What is the duration of a bond with a
$1,000 face value, 10% coupon, 3 years
to maturity but the YTM is 5%?The
bond’s price is $1,136.16.
100 * 1 100 * 2 100 * 3 1,000 * 3
1
+ 2
+ 3
+
(1.05) (1.05) (1.05) (1.05)3 3,127.31
D= = = 2.75 years
1136.16 1,136.16
 Measuring Duration

 Example
 What is the duration of a bond with a
$1,000 face value, 10% coupon, 3 years
to maturity but the YTM is 20%?The
bond’s price is $789.35.
100 * 1 100 * 2 100 * 3 1,000 * 3
1
+ 2
+ 3
+
(1.20) (1.20) (1.20) (1.20)3 2,131.95
D= = = 2.68 years
789.35 789.35
Measuring Duration

 Example
 What is the duration of a zero coupon bond
with a $1,000 face value, 3 years to maturity
but the YTM is 12%?

1,000 * 3
(1.12)3 2,135.34
D= = = 3 years
1,000 711.78
(1.12)3
 By definition, the duration of a zero coupon
bond is equal to its maturity
Duration and Modified Duration

 The greater the duration, the greater

the price sensitivity
 Modified Duration gives an estimate of
price volatility:
Macaulay' s Duration
Modified Duration =
(1 + i)
∆P
≅ - Modified Duration × ∆i
P
Effective Duration

 Effective Duration
 Used to estimate a security’s price
sensitivity when the security contains
embedded options.
 Compares a security’s estimated price in
a falling and rising rate environment.
Effective Duration

Pi- - Pi+
Effective Duration =
P0 (i+ - i- )

 Where:
Pi- = Price if rates fall
Pi+ = Price if rates rise
P0 = Initial (current) price
i+ = Initial market rate plus the increase in rate
i- = Initial market rate minus the decrease in rate
Effective Duration

 Example
 Consider a 3-year, 9.4 percent semi-
annual coupon bond selling for $10,000
par to yield 9.4 percent to maturity.
 Macaulay’s Duration for the option-free
version of this bond is 5.36 semiannual
periods, or 2.68 years.
 The Modified Duration of this bond is
5.12 semiannual periods or 2.56 years.
Effective Duration

 Example
 Assume, instead, that the bond is
callable at par in the near-term .
 If rates fall, the price will not rise much
above the par value since it will likely
be called
 If rates rise, the bond is unlikely to be

called and the price will fall

Effective Duration

 Example
 If rates rise 30 basis points to 5%
semiannually, the price will fall to
$9,847.72.
 If rates fall 30 basis points to 4.4%
semiannually, the price will remain at
par
$10,000 - $9,847.72
Effective Duration = = 2.54
$10,000( 0.05 - 0.044)
Duration GAP

 Duration GAP Model

 Focuses on either managing the market
value of stockholders’ equity
 The bank can protect EITHER the
market value of equity or net interest
income, but not both
 Duration GAP analysis emphasizes the
impact on equity
Duration GAP

 Duration GAP Analysis

 Compares the duration of a bank’s
assets with the duration of the bank’s
liabilities and examines how the
economic value stockholders’ equity
will change when interest rates
change.
Two Types of Interest Rate Risk

 Reinvestment Rate Risk

 Changes in interest rates will change
the bank’s cost of funds as well as the
return on invested assets
 Price Risk
 Changes in interest rates will change
the market values of the bank’s assets
and liabilities
Reinvestment Rate Risk

 If interest rates change, the bank will

have to reinvest the cash flows from
assets or refinance rolled-over
liabilities at a different interest rate in
the future
 An increase in rates increases a bank’s
return on assets but also increases the
bank’s cost of funds
Price Risk

 If interest rates change, the value of

assets and liabilities also change.
 The longer the duration, the larger the
change in value for a given change in
interest rates
 Duration GAP considers the impact of
changing rates on the market value of
equity
Reinvestment Rate Risk and Price Risk

 Reinvestment Rate Risk

 Ifinterest rates rise (fall), the yield from
the reinvestment of the cash flows
rises (falls) and the holding period
return (HPR) increases (decreases).
 Price risk
 If interest rates rise (fall), the price falls
(rises). Thus, if you sell the security
prior to maturity, the HPR falls (rises).
Reinvestment Rate Risk and Price Risk
 Increases in interest rates will
increase the HPR from a higher
reinvestment rate but reduce the HPR
from capital losses if the security is
sold prior to maturity.
 Decreases in interest rates will
decrease the HPR from a lower
reinvestment rate but increase the
HPR from capital gains if the security
is sold prior to maturity.
Reinvestment Rate Risk and Price Risk

 An immunized security or portfolio is

one in which the gain from the higher
reinvestment rate is just offset by the
capital loss.
 For an individual security,
immunization occurs when an
investor’s holding period equals the
duration of the security.
Steps in Duration GAP Analysis
 Forecast interest rates.
 Estimate the market values of bank assets,
liabilities and stockholders’ equity.
 Estimate the weighted average duration of
assets and the weighted average duration of
liabilities.
 Incorporate the effects of both on- and off-
balance sheet items. These estimates are
used to calculate duration gap.
 Forecasts changes in the market value of
stockholders’ equity across different interest
rate environments.
Weighted Average Duration of Bank Assets

 Weighted Average Duration of Bank

Assets (DA)
n
DA = ∑ w iDai
i
 Where
 wi = Market value of asset i divided by
the market value of all bank assets
 Da = Macaulay’s duration of asset i
i
 n = number of different bank assets
Weighted Average Duration of Bank Liabilities

 Weighted Average Duration of Bank

Liabilities (DL)
m
DL = ∑ z jDl j
j
 Where
 zj = Market value of liability j divided by
the market value of all bank liabilities
 Dl = Macaulay’s duration of liability j
j
 m = number of different bank liabilities
Duration GAP and Economic Value of Equity

 Let MVA and MVL equal the market values

of assets and liabilities, respectively.
 If: ΔEVE = ΔMVA − ΔMVL
and
Duration GAP
DGAP = DA - (MVL/MVA)DL
 Then:
 ∆y 
ΔEVE = - DGAP MVA
 (1 + y) 
 where y = the general level of interest
rates
Duration GAP and Economic Value of Equity

 To protect the economic value of

equity against any change when rates
change , the bank could set the
duration gap to zero:

 ∆y 
ΔEVE = - DGAP MVA
 (1 + y) 
 Hypothetical Bank Balance Sheet
1 Par Years Market
$1,000 % Coup Mat. YTM Value Dur.
Assets
Cash $100 $ 100
Earning assets
3-yr Commercial loan $ 700 12.00% 3 12.00% $ 700 2.69
6-yr Treasury bond $ 200 8.00% 6 8.00% $ 200 4.99
Total Earning Assets $ 900 11.11% $ 900
84 ×1 84 × 2 84 × 3 700 × 3
Non-cash earning assets
Total assets
+ $ -
+ + $ -

(1.12) (1.12) (1.12) (1.12) 3 2.88

$ 1,000
1 2 10.00%
3 $ 1,000

Liabilities D=
Interest bearing liabs. 700
1-yr Time deposit $ 620 5.00% 1 5.00% $ 620 1.00
3-yr Certificate of deposit $ 300 7.00% 3 7.00% $ 300 2.81
Tot. Int Bearing Liabs. $ 920 5.65% $ 920
Tot. non-int. bearing $ - $ -
Total liabilities $ 920 5.65% $ 920 1.59
Total equity $ 80 $ 80
Total liabs & equity $ 1,000 $ 1,000
Calculating DGAP
 DA
 ($700/$1000)*2.69 + ($200/$1000)*4.99 = 2.88
 DL
 ($620/$920)*1.00 + ($300/$920)*2.81 = 1.59
 DGAP
 2.88 - (920/1000)*1.59 = 1.42 years
 What does this tell us?
 The average duration of assets is greater than the
average duration of liabilities; thus asset values
change by more than liability values.
 1 percent increase in all rates.
1 Par Years Market
$1,000 % Coup Mat. YTM Value Dur.
Assets
Cash $ 100 $ 100
Earning assets
3-yr Commercial loan $ 700 12.00% 3 13.00% $ 683 2.69
6-yr Treasury bond $ 200 8.00% 6 9.00% $ 191 4.97
Total Earning Assets $ 900 12.13% $ 875
Non-cash earning assets $ - $ -
84 700 2.86
PV = ∑t =1
Total assets $ 1,000 3 10.88% $ 975
t
+
Liabilities 1.13 1.13 3
Interest bearing liabs.
1-yr Time deposit $ 620 5.00% 1 6.00% $ 614 1.00
3-yr Certificate of deposit $ 300 7.00% 3 8.00% $ 292 2.81
Tot. Int Bearing Liabs. $ 920 6.64% $ 906
Tot. non-int. bearing $ - $ -
Total liabilities $ 920 6.64% $ 906 1.58
Total equity $ 80 $ 68
Total liabs & equity $ 1,000 $ 975
Calculating DGAP
 DA
 ($683/$974)*2.68 + ($191/$974)*4.97 = 2.86
 DL
 ($614/$906)*1.00 + ($292/$906)*2.80 = 1.58
 DGAP
 2.86 - ($906/$974) * 1.58 = 1.36 years
 What does 1.36 mean?
 The average duration of assets is greater than the
average duration of liabilities, thus asset values
change by more than liability values.
Change in the Market Value of Equity

∆y
ΔEVE = - DGAP[ ]MVA
(1 + y)

 In this case:

.01
ΔEVE = - 1.42[ ]$1,000 = −$12.91
1.10
Positive and Negative Duration GAPs
 Positive DGAP
 Indicates that assets are more price sensitive
than liabilities, on average.
 Thus, when interest rates rise (fall), assets will
fall proportionately more (less) in value than
liabilities and EVE will fall (rise) accordingly.
 Negative DGAP
 Indicates that weighted liabilities are more
price sensitive than weighted assets.
 Thus, when interest rates rise (fall), assets will
fall proportionately less (more) in value that
liabilities and the EVE will rise (fall).
 DGAP Summary

DGAP Summary
Change in
DGAP Interest
Assets Liabilities Equity
Rates
Positive Increase Decrease > Decrease → Decrease
Positive Decrease Increase > Increase → Increase

Negative Increase Decrease < Decrease → Increase

Negative Decrease Increase < Increase → Decrease

Zero Increase Decrease = Decrease → None

Zero Decrease Increase = Increase → None
An Immunized Portfolio
 To immunize the EVE from rate
changes in the example, the bank
would need to:
 decrease the asset duration by 1.42
years or
 increase the duration of liabilities by
1.54 years
 DA / ( MVA/MVL)
= 1.42 / ($920 / $1,000)
= 1.54 years
Immunized Portfolio
$1,000 % Coup Mat. YTM Value Dur.
Assets
Cash $ 100 $ 100
Earning assets
3-yr Commercial loan $ 700 12.00% 3 12.00% $ 700 2.69
6-yr Treasury bond $ 200 8.00% 6 8.00% $ 200 4.99
Total Earning Assets $ 900 11.11% $ 900
Non-cash earning assets$ - $ -
Total assets $ 1,000 10.00% $ 1,000 2.88

Liabilities
Interest bearing liabs.
1-yr Time deposit $ 340 5.00% 1 5.00% $ 340 1.00
3-yr Certificate of deposit$ 300 7.00% 3 7.00% $ 300 2.81
6-yr Zero-coupon CD* $ 280 0.00% 6 0.00% $ 280 6.00
Tot. Int Bearing Liabs. $ 920 4.13% $ 920
Tot. non-int. bearing $ - $ -
Total liabilities $ 920 4.13% $ 920 3.11
Total equity $ 80 $ 80
Total liabs & equity 1000.0 1000

DGAP = 2.88 – 0.92 (3.11) ≈ 0

Immunized Portfolio with a 1% increase in rates

Assets
Cash $ 100.0 $ 100.0
Earning assets
3-yr Commercial loan $ 700.0 12.00% 3 13.00% $ 683.5 2.69
6-yr Treasury bond $ 200.0 8.00% 6 9.00% $ 191.0 4.97
Total Earning Assets $ 900.0 12.13% $ 874.5
Non-cash earning assets$ - $ -
Total assets $ 1,000.0 10.88% $ 974.5 2.86

Liabilities
Interest bearing liabs.
1-yr Time deposit $ 340.0 5.00% 1 6.00% $ 336.8 1.00
3-yr Certificate of deposit$ 300.0 7.00% 3 8.00% $ 292.3 2.81
6-yr Zero-coupon CD* $ 280.0 8.00% 6 9.00% $ 267.4 6.00
Tot. Int Bearing Liabs. $ 920.0 7.55% $ 896.5
Tot. non-int. bearing $ - $ -
Total liabilities $ 920.0 7.55% $ 896.5 3.08
Total equity $ 80.0 $ 78.0
Total liabs & equity $ 1,000.0 $ 974.5
Immunized Portfolio with a 1% increase in rates

 EVE changed by only $0.5 with the

immunized portfolio versus $25.0
when the portfolio was not immunized.
Stabilizing the Book Value of Net Interest Income

 This can be done for a 1-year time horizon,

with the appropriate duration gap measure
 DGAP* MVRSA(1- DRSA) - MVRSL(1- DRSL)
where:
 MVRSA = cumulative market value of RSAs
 MVRSL = cumulative market value of RSLs
 DRSA = composite duration of RSAs for the
given time horizon
 Equal to the sum of the products of each asset’s
duration with the relative share of its total asset
market value
 DRSL = composite duration of RSLs for the
given time horizon
 Equal to the sum of the products of each liability’s
duration with the relative share of its total liability
market value.
Stabilizing the Book Value of Net Interest Income

 If DGAP* is positive, the bank’s net interest

income will decrease when interest rates
decrease, and increase when rates increase.
 If DGAP* is negative, the relationship is
reversed.
 Only when DGAP* equals zero is interest
rate risk eliminated.
 Banks can use duration analysis to stabilize
a number of different variables reflecting
bank performance.
Economic Value of Equity Sensitivity Analysis

 Effectively involves the same steps as

earnings sensitivity analysis.
 In EVE analysis, however, the bank
focuses on:
 The relative durations of assets and
liabilities
 How much the durations change in
different interest rate environments
 What happens to the economic value of
equity across different rate environments
Embedded Options

 Embedded options sharply influence the

estimated volatility in EVE
 Prepayments that exceed (fall short of)
that expected will shorten (lengthen)
duration.
 A bond being called will shorten duration.
 A deposit that is withdrawn early will
shorten duration.
 A deposit that is not withdrawn as
expected will lengthen duration.
 First Savings Bank Economic Value of Equity
Market Value/Duration Report as of 12/31/04
Most Likely Rate Scenario-Base Strategy
Assets

Book Value Market Value Book Yield Duration*

Loans
Prime Based Ln $ 100,000 $ 102,000 9.00%
Equity Credit Lines $ 25,000 $ 25,500 8.75% -
Fixed Rate > I yr $ 170,000 $ 170,850 7.50% 1.1
Var Rate Mtg 1 Yr $ 55,000 $ 54,725 6.90% 0.5
30-Year Mortgage $ 250,000 $ 245,000 7.60% 6.0
Consumer Ln $ 100,000 $ 100,500 8.00% 1.9
Credit Card $ 25,000 $ 25,000 14.00% 1.0
Total Loans $ 725,000 $ 723,575 8.03% 2.6
Loan Loss Reserve $ (15,000) $ 11,250 0.00% 8.0
Net Loans $ 710,000 $ 712,325 8.03% 2.5
Investments
Eurodollars $ 80,000 $ 80,000 5.50% 0.1
CMO Fix Rate $ 35,000 $ 34,825 6.25% 2.0
US Treasury $ 75,000 $ 74,813 5.80% 1.8
Total Investments $ 190,000 $ 189,638 5.76% 1.1
Fed Funds Sold $ 25,000 $ 25,000 5.25% -
Cash & Due From $ 15,000 $ 15,000 0.00% 6.5
Non-int Rel Assets $ 60,000 $ 60,000 0.00% 8.0
Total Assets $ 100,000 $ 100,000 6.93% 2.6
 First Savings Bank Economic Value of Equity
Market Value/Duration Report as of 12/31/04
Liabilities
Most Likely Rate Scenario-Base Strategy

Book Value Market Value Book Yield Duration*

Deposits
MMDA $ 240,000 $ 232,800 2.25% -
Retail CDs $ 400,000 $ 400,000 5.40% 1.1
Savings $ 35,000 $ 33,600 4.00% 1.9
NOW $ 40,000 $ 38,800 2.00% 1.9
DDA Personal $ 55,000 $ 52,250 8.0
Comm'l DDA $ 60,000 $ 58,200 4.8
Total Deposits $ 830,000 $ 815,650 1.6
TT&L $ 25,000 $ 25,000 5.00% -
L-T Notes Fixed $ 50,000 $ 50,250 8.00% 5.9
Fed Funds Purch - - 5.25% -
NIR Liabilities $ 30,000 $ 28,500 8.0
Total Liabilities $ 935,000 $ 919,400 2.0
Equity $ 65,000 $ 82,563 9.9
Total Liab & Equity $ 1,000,000 $ 1,001,963 2.6
Off Balance Sheet Notional
lnt Rate Swaps - $ 1,250 6.00% 2.8 50,000
Adjusted Equity $ 65,000 $ 83,813 7.9
Duration Gap for First Savings Bank EVE

 Market Value of Assets

 $1,001,963

 Duration of Assets
 2.6 years
 Market Value of Liabilities
 $919,400

 Duration of Liabilities
 2.0 years
Duration Gap for First Savings Bank EVE

 Duration Gap
= 2.6 – ($919,400/$1,001,963)*2.0
= 0.765 years
 Example:
A 1% increase in rates would reduce
EVE by $7.2 million
= 0.765 (0.01 / 1.0693) * $1,001,963
 Recall that the average rate on assets
is 6.93%
 Sensitivity of EVE versus Most Likely (Zero Shock)
Interest Rate Scenario

2 0 .0
C h a n g e in E V E (m illio n s o f d o lla r s )

1 3 .6
8 .8 8 .2
1 0 .0

( 1 0 .0 )
A L C O G u id e lin e (8 .2 )
B o a r d L im it
( 2 0 .0 )
( 2 0 .4 )
( 3 0 .0 )
( 3 6 .6 )
( 4 0 .0 )
-3 0 0 -2 0 0 -1 0 0 0 +100 +200 +300
S h o c k s to C u rre n t R a te s
Sensitivity of Economic Value of Equity measures the change
in the economic value of the corporation’s equity under
various changes in interest rates. Rate changes are
instantaneous changes from current rates. The change in
economic value of equity is derived from the difference
between changes in the market value of assets and changes
Effective “Duration” of Equity

 By definition, duration measures the

percentage change in market value for
a given change in interest rates
 Thus,a bank’s duration of equity
measures the percentage change in
EVE that will occur with a 1 percent
change in rates:
 Effective duration of equity
9.9 yrs. = $8,200 / $82,563
Asset/Liability Sensitivity and DGAP
 Funding GAP and Duration GAP are NOT
directly comparable
 Funding GAP examines various “time
buckets” while Duration GAP represents
the entire balance sheet.
 Generally, if a bank is liability (asset)
sensitive in the sense that net interest
income falls (rises) when rates rise and
vice versa, it will likely have a positive
(negative) DGAP suggesting that assets
are more price sensitive than liabilities, on
average.
 Strengths and Weaknesses: DGAP and EVE-
Sensitivity Analysis
 Strengths
 Duration analysis provides a
comprehensive measure of interest rate
risk
 Duration measures are additive
 This allows for the matching of total
assets with total liabilities rather than the
matching of individual accounts
 Duration analysis takes a longer term
view than static gap analysis
 Strengths and Weaknesses: DGAP and EVE-
Sensitivity Analysis
 Weaknesses
 It is difficult to compute duration
accurately
 “Correct” duration analysis requires that
each future cash flow be discounted by a
distinct discount rate
 A bank must continuously monitor and
adjust the duration of its portfolio
 It is difficult to estimate the duration on
assets and liabilities that do not earn or
pay interest
 Duration measures are highly subjective
Speculating on Duration GAP

 It is difficult to actively vary GAP or

DGAP and consistently win
 Interest rates forecasts are frequently
wrong
 Even if rates change as predicted,
banks have limited flexibility in vary
GAP and DGAP and must often
sacrifice yield to do so
Gap and DGAP Management Strategies
Example
 Cash flows from investing $1,000 either
in a 2-year security yielding 6 percent or
two consecutive 1-year securities, with
the current 1-year yield equal to 5.5
percent. 0 1 2
Two-Year Security

$60 $60
0 1 2
One-Year Security & then
another One-Year Security

$55 ?
Gap and DGAP Management Strategies
Example
 It is not known today what a 1-year
security will yield in one year.
 For the two consecutive 1-year
securities to generate the same $120 in
interest, ignoring compounding, the 1-
year security must yield 6.5% one year
from the present.
 This break-even rate is a 1-year forward
rate, one year from the present:
 6% + 6% = 5.5% + x
so x must = 6.5%
Gap and DGAP Management Strategies
Example
 By investing in the 1-year security, a
depositor is betting that the 1-year
interest rate in one year will be greater
than 6.5%
 By issuing the 2-year security, the
bank is betting that the 1-year interest
rate in one year will be greater than
6.5%
Yield Curve Strategy
 When the U.S. economy hits its peak,
the yield curve typically inverts, with
short-term rates exceeding long-term
rates.
 Only twice since WWII has a recession
not followed an inverted yield curve
 As the economy contracts, the Federal
Reserve typically increases the money
supply, which causes the rates to fall
and the yield curve to return to its
“normal” shape.
Yield Curve Strategy

 To take advantage of this trend, when

the yield curve inverts, banks could:
 Buy long-term non-callable securities
 Prices will rise as rates fall
 Make fixed-rate non-callable loans
 Borrowers are locked into higher rates
 Price deposits on a floating-rate basis
 Lengthen the duration of assets
relative to the duration of liabilities
 Interest Rates and the Business Cycle
The general level of interest rates and the shape of the yield curve
appear to follow the U.S. business cycle.

Peak In expansionary Short-TermRates

stages rates rise until
they reach a peak as
t) the Federal Reserve Long-TermRates
n tightens credit
e
c
r
availability.
e
P( Expansion The inverted yield curve has predicted the last
s five recessions
e
t DATE WHEN 1-YEAR RATE LENGTH OF TIME UNTIL
a Contraction FIRST EXCEEDS 10-YEAR RATE START OF NEXT RECESSION
R
t Expansion
Apr. ’68 20 months (Dec. ’69)
s Mar. ’73 8 months (Nov. ’73)
e In contractionary Sept. ’78 16 months (Jan. ’80)
r stages rates fall until
e
t they reach a trough
Sept. ’80 10 months (July ’81)

n Trough Feb. ’89 17 months (July ’90)

I when the U.S. Dec. ’00 15 months (March ’01)

economy falls into

recession.
Time
 Bank Management,
Management 6th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2006 by South-Western, a division of Thomson Learning

Managing Interest Rate Risk:

Duration GAP and Economic Value
of Equity

Chapter 6

William Chittenden edited and updated the PowerPoint slides for this edition.