Interest Rate Movements Research Articles

A new index for bond management in an uncertain environment

Within the framework of Assets Liability Management, we understand that immunization is the main method to assure a certain yield in a future date departing from an initial portfolio. Although the objective of passive strategies is to design a portfolio that will achieve the performance of a predetermined benchmark, active bond management strategies rely on expectations of interest rate movements or changes in yield–spread relationships. However, the variation of the duration increases the risk of a portfolio, that why the decision maker will have to choose the combination of expected return and risk which provides the higher utility. Finally, the construction of a fuzzy return risk map will allow the decision maker to know the over risk and the over return as regards immunization strategy for each duration and for each risk aversion of the decision maker. The construction of a risk return map presents the results in an appropriate way. It will help the decision maker to choose the best duration for the decision maker interest rate forecast. Finally, this methodology is applied to the Spanish debt so that the decision maker can select the duration that brings him a greater preference.

Convertible bond valuation in a jump diffusion setting with stochastic interest rates

This paper proposes an integrated pricing framework for convertible bonds, which comprises firm value evolving as an exponential jump diffusion, correlated stochastic interest rates movements and an efficient numerical pricing scheme. By construction, the proposed stochastic model fits in the framework of affine jump diffusion processes of Duffie et al. [Econometrica, 2000, 68, 1343–1376] with tractable behaviour. We define the firm’s optimal call policy and investigate its impact on the computed convertible bond prices. We illustrate the performance of the numerical scheme and highlight the effects originated by the inclusion of jumps, stochastic interest rates and a non-zero correlation structure between firm value and interest rates.

A Continuous-Time Dynamics of Interest Cash Flows from a Bankks Loan Portfolio

A continuous-time deterministic model for analytical simulation of impact of the change in yield curve on bank’s interest income from a fixed rate loans portfolio is presented. It is considered both differential and integral presentations of equations for dynamics of principal and interest cash flows. The model allows taking into account the arbitrary movements in interest rates. Examples of calculation of total (from portfolio) and partial (across maturities) interest cash flows and corresponding interest rates on those cash flows are given. The sensitivity of total interest cash flows is evaluated for some changes in yield curve on loans that obeys the Nelson-Siegel model.

Generating HistoricallyyBased Stress Scenarios Using Parsimonious Factorization

We describe an empirical approach to generating plausible historically‐based interest rate shocks, which can be applied to any market environment and readily linked to movements in other key risk factors. Our approach is based upon yield curve parameterization and requires a parsimonious yet flexible factorization model. In the process of selecting a model, we evaluate three variants of the Nelson‐Siegel approach to yield curve approximation and find that, in the current low interest rate environment, a 5‐factor parameterization developed by Bjork and Christensen (1999) is best suited for accurately translating historical interest rate movements into plausible, current period shocks. Using the Bjork‐Christensen model, we parameterize a time series of historical yield curves and measure interest rate shocks as the historical change in each of the model’s factors. We then demonstrate how to add these parameterized shocks to any market environment, while retaining positive rates and plausible credit spreads. Given a set of shocked interest rate curves, joint risk factor movements are calculated based upon historical, reduced form dependencies.

The Response of Equity Prices to Movements in Long-Term Interest Rates Associated with Monetary Policy Statements: Before and after the Zero Lower Bound

Monetary policy actions since 2008 have influenced long-term interest rates through forward guidance and quantitative easing. We propose a strategy to identify the comovement between interest rate and equity price movements induced by monetary policy when an observable representing policy changes, such as changes in the interbank rate, is not available. A decline in long-term interest rates induced by monetary policy statements prior to 2009 is accompanied by a 6- to 9-percent increase in equity prices. This association is substantially attenuated in the period since the zero-lower bound has been binding - with a policy-induced 100 basis-point decline in 10-year Treasury yields associated with a 1½- to 3-percent increase in equity prices. Empirical analysis suggests this attenuation does not represent a change in responses to monetary-policy induced movements in interest rates, but reflects the importance of both short- and long-term interest rates.

Notas sobre fetichismo, historia e incertidumbre: más allá de la crítica a la austeridad

We are in the middle of huge wave of uprisings, of massive, multitudinous refusals to accept the contemporary conditions. The article asks what it means to say NO in a society in which the poor and miserable are required to subsidise the financial system for the sake of sustaining the illusion of abstract wealth. This subsidy is necessary in existing society, to secure its wealth and prevent its implosion. Capitalist society cannot be fought in a direct and immediate manner - what really does it mean to struggle against money, resist the movement of coins, combat the movement of interest rates, fight price movements, and resist poverty in a mode of social reproduction that entails the pauper in its concept of wealth? The refusal to sanction things as they are is entirely negative of the existing conditions of social reproduction. It demands that their further progress comes to a standstill.

Do the Keynesian monetary transmission mechanisms work in the MENA region?

In this article, we empirically examine the operation of the traditional Keynesian interest rate channel of the monetary policy transmission mechanism in five emerging economies in the Middle East and North Africa (MENA) region and compare it with 14 inflation targeting (IT) emerging market economies (EMEs) using dynamic panel data analysis. Contrary to some existing studies, our empirical results provide no support for the argument that the traditional Keynesian interest rate channel is weak or does not operate effectively in the MENA region: both private consumption and investment in the MENA EMEs are sensitive to movements in real interest rates (although, in the case of private consumption, not independently of the level of financial development). We also find that interest rate elasticities of private consumption and private investment vary significantly with the level of development of the domestic financial market in the MENA EMES comparable to that in IT countries. Finally, our findings suggest that liberalization of the capital account has a significantly positive impact on private sector demand in MENA EMEs similar to that in the IT EMEs.

Term Spread Regressions of the Rational Expectations Hypothesis of the Term Structure Allowing for Risk Premium Effects

This paper suggests term spread regression based tests allowing for time-varying term premium effects, with the aim of explaining the empirical failures of the term spread to forecast future movements in interest rates. To capture the e¤ects of a time-varying term premium on the term spread, the paper relies on a simple and empirically attractive arbitrage-free Gaussian dynamic term structure model, which assumes that the term structure of interest rates is spanned by three unobserved factors. To retrieve these factors from the data, the paper suggests a new empirically methodology which can overcome the effects of measurement (or pricing) errors on the estimates of the unobserved factors, and our tests. The results of the paper indicate that term spread regressions allowing for a time-varying term premium effects can provide unbiased estimates of future changes of long-term interest rates, as predicted by the rational expectations hypothesis of the term structure.

Derivative activities and Chinese banks’ exposures to exchange rate and interest rate movements

This study investigates the impact of Chinese banks’ derivative activities on their exposure to exchange rate and interest rate changes. The standard Jorion [1990. “The Exchange-Rate Exposure of U.S. Multinationals.” Journal of Business 63 (3): 331–345] model provides weak evidence of Chinese banks’ exposure to these risks. However, the exposure increases substantially when time-varying exposure regressions with orthogonalised market returns are used. We also show that Chinese banks exhibit linear and nonlinear exposures to the exchange rate and interest rate fluctuations. Further analysis indicates that the use of derivatives reduces banks’ foreign exchange risk, but does not affect their interest rate exposure. Derivative products are more likely to be used as an integrated part of the Chinese banks’ risk management systems, which could thus help to stabilise the banking system.

Interest rate risk propagation: Evidence from the credit crunch

During the 2007–2009 financial crisis, US subprime mortgage risk exposures led to severe liquidity problems in several other foreign markets. Such risk contagion was caused by enormous changes in interest rates. Although risk contagion has been investigated by several literatures, the magnitude of propagated interest rate risk around global financial markets remains unexplored. Therefore, this study quantifies the degree to which the increased credit risk within the US financial system propagated to the European markets’ liquidity risks. Specifically, using a conditional value-at-risk (CoVaR) model, we quantitatively measure interest rate risk of a European country, by looking at the upside risk in distribution of changes in interest rate. And such propagation risk measure considers additional value-at-risk conditional on the interest rate movements in the US. The results show significantly positive differences between European country's value-at-risk conditional on the US financial markets being in a normal or distressed state. This propagating effect increased from 2007, and was particularly pronounced in the 2008–2009. In addition, the interest rate risk contagion is especially severe for some countries in the Euro regions with greater sovereign debt problems. Hence our result foretells the deterioration of the European sovereign debt crisis which started to unfold in 2010. Our work supplements the literature by successfully quantifying the magnitude of additional interest rate risk conditional on risk exposure from external sectors.

Permuta Financiera SWAP

El manejo de la gestión de riegos de mercado se puede realizar a través de los llamados productos derivados con fines de cobertura; la permuta financiera (swap) es uno de los instrumentos financieros a disposición del gerente financiero y que es materia del presente artículo; asimismo, se presentan casos aplicativos para que la empresa mitigue la posibilidad de que sufra pérdidas debido a movimientos inopinados y adversos en los tipos de interés, tipo de cambio, precios bursátiles y de las materias primas o commodities.

Inflation and interest rate movements in Ghana: trends and possible causal links

The relationship between inflation and interest rate has remained controversial in Ghana and this called for the investigation into the trends and causal links between the two variables. Monthly observations from 1995 to 2011 were used for analyses of trends, causality, cointegration and error correction model. The study reveals significant trends of variability over time with the trend of inflation being more volatile relative to interest rate. There is a two-way causal relationship between inflation and nominal interest rate and there exists also a long-run equilibrium relationship between the variables. The results suggest inflation in Ghana in the short-run depends on previous month’s inflation rate and past interest rates, but not on current interest rate. The impulse response shows past inflation rates and nominal interest rates account for macroeconomic instability in the economy. It is recommended long-run policy measures be used to promote macroeconomic stability.

Are Deposit and Investment Accounts in Islamic Banks in Malaysia Interest-Free?

Islamic banking and Finance (IBF) provides products and services guided by the Sharīʿah. Therefore, they are supposed to be different from their conventional counterparts. Islamic deposit rates should be different from conventional deposit rates. Islamic banking profit rates are supposedly less risky due to risk-sharing attribute embedded in their structure as compared to the Conventional banking interest rates on similar-risk investment products. This paper addresses this concern by examining the differences in the monthly fixed deposit rates of conventional and investment deposit rates of Islamic banks and finance companies in Malaysia for the period from January 1994 to December 2012 and determines the causality relationship between profit rates and interest rates on these investments. The findings suggest that profit rates of Islamic banks are significantly linked with interest rates of conventional banks. The findings also indicate that profit rates of Islamic banks and finance companies are affected by the movements of interest rates of conventional banks and finance companies respectively and not vice versa. The findings imply that there is a gap between Islamic banking theory and practice. Lack of infrastructure for full compliance and lack of stringent enforcement of regulatory requirements are possible reasons for such behavior of Islamic financial institutions in Malaysia.

RECENT DECISIONS OF ITALIAN COURTS ON INTEREST RATE SWAPS

RECENT DECISIONS OF ITALIAN COURTS ON INTEREST RATE SWAPS

A Financial Econometric Analysis of the Determinants of Interest Rate Risk in the US

1. Introduction Capital in a market-oriented economy is allocated through the price system. The interest rate is the price of capital paid to borrow debt capital. The factors that affect supply of and demand for capital (funds) determine the cost of capital, too. The risk of capital losses to which suppliers and demanders of capital are exposed because of unanticipated changes of interest rates is called as the interest rate risk (Thalassinos et al., 2010). This risk is measured by a component, added on the base rate (the real risk-free rate of interest), which is called the risk premium. The risk increases the risk premia on interest rates and it is reallocated among people in our economy, from the riskiest to the less risky ones. All agents of an economy, suppliers or demanders of funds, are exposed to interest rate risk. Everyone is sensitive to interest rate movements and this volatility has increased significantly. Since it is difficult to predict the direction and magnitude of interest rate changes, borrowers and lenders (especially shorter-maturity and variable-rate debts) face an interest rate exposure. There is a type of interest rate risk that affects every participant in the financial markets, the basis risk, which is the mismatching of interest rate bases for associated assets and liabilities. A second type of risk is the gap risk (more typical of a nonfinancial firm) which arises from mismatched timing in repricing interest-rate-sensitive assets and liabilities. For financial institutions, portfolio managers, and investment on securities, there are also a price risk and a reinvestment risk. Another risk is due to the average expected inflation rate over the life of a loan. Inflation erodes the purchasing power of the dollar and causes capital losses (lowers the real rate of return). In addition, there is a risk that the borrower could default on a loan. Besides, a liquidity risk exists because the financial assets cannot be converted to cash quickly and at a fair market value. Moreover, a maturity risk occurs due to high price sensitivity of long-term securities whenever interest rates rise. On the other hand, the reinvestment risk is the risk that affects more the short-term securities because a decline in interest rates will lead to lower income when financial instrument matures and funds are reinvested. Further, a foreign exchange risk (unexpected changes in exchange rates) can cause capital losses by altering the home currency value of foreign currency receipts or payments (Thalassinos, 2007). Likewise, a political risk may exist due to the possibility that political events in a particular country will cause some capital losses from expecting capital outflows from that country. Given the interest rate risks, every participant in the financial market requires a compensation for undertaking these risks. This remuneration is called the interest rate risk premium. We are interested to determine the factors that affect the different components of risk premier. The intelligent supplier or demander of capital must have knowledge of these factors affecting risk premium (and then interest rate) and be able to anticipate possible future changes in those factors. We are defining as risk premium the difference between a market rate of interest and the real risk-free rate of interest. [IRRP.sub.t] [congruent to] [RP.sub.t] = [i.sub.t] - [r.sub.t.sup.*] (1) where, IRRPt = interest rate risk premium, RPt = risk premium, it = a nominal market rate of interest and [rt.sup.*] = the real risk-free rate of interest (3-month T-bill rate minus the expected inflation rate). Consequently, risk premia are the prices of risk (components of the rate of return) built in financial assets priced (return) against the uncertainties related to the relevant state variables in our inherited risky economic system. As the uncertainties of the state variables (expected macro- variables) change over time, the risk related to the state macro-variables and hence the risk premia on interest rates vary over time. …

Generating historically-based stress scenarios using parsimonious factorization

Purpose – This paper aims to describe a robust empirical approach to generating plausible historically based interest rate shocks, which can be applied to any market environment. These interest rate shocks can be readily linked to movements in other key risk factors, and used to measure market risk on institutions with large fixed-income portfolios. Design/methodology/approach – Using yield curve factorization, we parameterize a time series of historical yield curves and measure interest rate shocks as the historical change in each of the model’s factors. We then demonstrate how to add these parameterized shocks to any market environment, while retaining positive rates and plausible credit spreads. Given a set of shocked interest rate curves, joint risk factor movements are calculated based upon historical, reduced form dependencies. Findings – Our approach is based upon yield curve parameterization and requires a parsimonious yet flexible factorization model. In the process of selecting a model, we evaluate three variants of the Nelson–Siegel approach to yield curve approximation and find that, in the current low interest rate environment, a 5-factor parameterization developed by Björk and Christensen (1999) is best suited for accurately translating historical interest rate movements into plausible, current period shocks. Originality/value – An accurate measure of market risk can help to inform institutions about the amount of capital needed to withstand a series of adverse market events. A plausible set of shocks is required to ensure market value, and cash flow projections are indicative of meaningful market sensitivities.

Interest rates and international debt crisis

It has often been claimed that the international debt crisis has been made worse by the high level of interest rates payable on the debt. The purpose of this article is to analyse the recent evolution of interest rates and the contribution this has made to precipitating the crisis. A recent history of interest rate movements is presented, together with some relevant debt figures. This leads to an examination of various explanations of the debt crisis and the role that high interest rates may have played in the problem.

The impact of monetary policy on oil price persistence: An application of the smooth regime-switching model

This paper employs the smooth transition autoregressive model to evaluate the persistence of oil price changes, and chooses monetary policy variables as transition variables of the model to assess their roles in the persistence effects. The empirical results show that oil price changes displayed asymmetric adjustments within different regimes and were more sensitive to the movement of interest rates than inflation rate. In addition, high inflation rate would give rise to low oil price persistence, and expansionary monetary policy would bring about higher oil price persistence. Moreover, when the short- and long-term interest rates were over their threshold values, the persistence effects of oil price changes were opposite. In the present relatively low US interest rates, adopting either an inflation-targeting policy or/and a debt-financing policy to stimulate economic growth, the timing is appropriate and the effect will be positive and expected because of low persistence of oil price changes.

Financial Aspects of Interest Rate Derivative

An interest rate derivative is a derivative where the underlying asset is the right to pay or receive a notional amount of money at a given interest rate. These structures are popular for investors with customized cash flow needs or specific views on the interest rate movements (such as volatility movements or simple directional movements) and are therefore usually traded Over The Counter (OTC). The interest rate derivatives market is the largest derivatives market in the world. The Bank for International Settlements estimates that the notional amounts outstanding in June 2009 were US$437 trillion for OTC interest rate contracts, and US$342 trillion for OTC interest rate swaps. According to the International Swaps and Derivatives Association, 80% of the world's top 500 companies as of April 2003 used interest rate derivatives to control their cash flows. This compares with 75% for foreign exchange options, 25% for commodity options and 10% for stock options. Modeling of interest rate derivatives is usually done on a time-dependent multi-dimensional Lattice (tree) built for the underlying risk drivers, usually domestic or foreign short rates and foreign exchange market rates, and incorporating delivery- and day-count conventions. Specialized models are also often used. The trading in Interest Rate Futures was launched on the National Stock Exchange of India (NSE) on 31st August 2009 and will be launched shortly on MCX Stock Exchange (MCX-SX).

The Design and Estimation of a Bi-National Bond to Finance Strategic Infrastructure along the U.S.–Mexico Border

The magnitude of funds needed to improve infrastructure along the U.S.–Mexico border has substantially outstripped the sources, resulting in a deteriorating environment and border security and placing the inhabitants at risk. Traditionally, the federal government in each country allocates a small budget to the North American Development Bank (NADB), a bi-national institution that manages infrastructure development. This article defines a bi-national bond that can be issued by the NADB in U.S. dollars and/or Mexican pesos and estimates the spread for default risk and premiums for the built-in hedge against adverse movements in interest rates and exchange rates. As of May 2012, the authors estimate a B rated, two-year zero, bi-national bond denominated in pesos will yield 9.645% without the hedge and 2.86% with the interest rate and exchange rate hedges. The structured feature of the bond helps in lowering the cost of financing. <b>TOPICS:</b>Project finance, other real assets, legal/regulatory/public policy, emerging