Internal Liquidity Adequacy Assessment Process and Modified duration: Difference between pages

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''Bank supervision - liquidity risk.''
(MD).  


(ILAAP).
Modified duration is an estimate of the market price sensitivity of an instrument, to small changes in yield.


The Internal Liquidity Adequacy Assessment Process of a bank takes the form of a document which:
It is the related proportionate price change of a market instrument or portfolio.
*Provides details of how the bank manages its liquidity position; and
*Explains the bank's management and control processes.




It is approved by the bank's management body, and submitted to the regulator as part of the regulator's liquidity review of the bank.
The estimate of change in market price is given by:
 
'''Modified duration x Starting Market price x Change in yield'''
 
 
Often - but not always - the relevant yield is defined as the annual effective yield (EAR).
 
For changes in EAR, modified duration is calculated from Macaulay’s duration as:
 
 
MD = Duration / (1 + EAR)
 
 
For changes in simple nominal annual yields (R), modified duration is calculated as:
 
 
MD = Duration / (1 + (R / n) )
 
where n = number of compounding periods per year.
 
 
<span style="color:#4B0082">'''Example: Modified duration calculations'''</span>
 
Duration = 5.00 years.
 
Semiannual yield R = 6.00% (so n = 2)
 
and so EAR = 6.09%.
 
 
(i) With respect to the EAR:
 
MD = 5.00 / 1.0609
 
= 4.71
 
 
(ii) With respect to the Semiannual yield:
 
MD = 5.00 / 1.03
 
= 4.85
 
This shows that there would be a greater proportionate change in price for a 1% change in the Semiannual yield, than for a 1% change in the EAR.




== See also ==
== See also ==
* [[Bank supervision]]
* [[Convexity]]
* [[Governance]]
* [[Duration]]
* [[ICAAP]]
* [[Effective annual rate]]
* [[ILAA]]
* [[Macaulay duration]]
* [[OLAR]]
* [[Matching]]
* [[SREP]]
* [[Modified convexity]]
* [[Price value of a basis point]]
* [[Semi-annual rate]]
* [[Volatility]]

Revision as of 14:05, 16 November 2016

(MD).

Modified duration is an estimate of the market price sensitivity of an instrument, to small changes in yield.

It is the related proportionate price change of a market instrument or portfolio.


The estimate of change in market price is given by:

Modified duration x Starting Market price x Change in yield


Often - but not always - the relevant yield is defined as the annual effective yield (EAR).

For changes in EAR, modified duration is calculated from Macaulay’s duration as:


MD = Duration / (1 + EAR)


For changes in simple nominal annual yields (R), modified duration is calculated as:


MD = Duration / (1 + (R / n) )

where n = number of compounding periods per year.


Example: Modified duration calculations

Duration = 5.00 years.

Semiannual yield R = 6.00% (so n = 2)

and so EAR = 6.09%.


(i) With respect to the EAR:

MD = 5.00 / 1.0609

= 4.71


(ii) With respect to the Semiannual yield:

MD = 5.00 / 1.03

= 4.85

This shows that there would be a greater proportionate change in price for a 1% change in the Semiannual yield, than for a 1% change in the EAR.


See also