Yield Curves/Managing Money Market Portfolios/Risk Management

Yield Curves

  • Graphic representation showing the relationship between yield and maturities of a particular instrument at a given point of time

Positive Yield Curve

  • Interest rates is expected to move higher in the future
  • Borrowers borrow long and lenders lend short
  • Delay purchase of long-term securities

Negative Yield Curve

  • Borrowers borrow short, Lenders lend long
  • Buy longer term securities
  • Shift short-term securities to longer term securities


  • Interest rates are not the same from short dates to one year
  • Market is currently in a consolidating phase

Managing Money Market Portfolio

Run Matched Book

  • Attempts to match the maturities of its assets with its liabilities
  • Conservative approach
  • Minimal interest income
  • Not prepared to be exposed to interest rate movements

Run Mismatched Book

  • The maturities of banks assets and liabilities are not perfectly matched
  • To increase interest income
  • Aggressive risk management approach
  • Bank exposed to full interest rate risk
  • Requires stop-loss policy

When To Use A Matched/Mismatched Book

  1. When it is not possible to run 100% matched book – different volume, maturities, amounts, interest rates and timing
  2. When back to back match is not possible (match bigger deals
  3. Unsure of interest rate movements, matched position
  4. Decide which to match and mismatch


Short Book Funded Strategy

  • Fund longer-term loans with shorter term deposits
  • Lends long borrow short (negative yield curve)
  • Faces liquidity, credit and income risk

Long Book Funded Strategy

  • Longer term liabilities and shorter term assets
  • Borrows long and lends short as bank is looking at a positive yield curve
  • Has advantage of increased liquidity and reduction of counterpart credit risk

Risk Management

  • The need to identify the various types of risk and how they could impact the business
  • Taking into account the official guidelines
  • Clearly documenting the levels of exposure the bank is prepared to accept (policies and approved limits)

Major Types of Money Market Risks

Credit Risk

  • Counterparty risk
  • Country risk
  1. Credit lines for counterparty and country
  2. Maturities of loans
  3. Amount limits

Liquidity Risk

  • Funding liquidity risk
  • Trading liquidity risk
  1. Diversifying investments
  2. Monitor market liquidity schedule
  3. Spreading asset maturities

Capital Related Risk

  • Bank’s Balance Sheet
  • Capital Adequacy Ratio
  1. Distribution of assets
  2. Monitor volume and quality of assets

Operational Risk

  • Poor Management
  • Poor Back Office Control
  • Support Systems
  • Fraud
  1. Internal control – china wall
  2. Quality of staff and system

Interest Rate Risk

  • Investment risk
  • Income risk
  1. Monitor monthly money market gap report
  2. Running matched books

Credit Risk

  • Risk that counterparty may not repay debts
  • Largest source of risk for a bank

Credit Review Process

  • Credit worthiness review
  • Trade off between giving large limits to trading room for profit or credit limits to control risk
  • Rating agencies provide  credit rating opinions on the credit worthiness of individuals and corporations
  • Trading room cannot create or increase given credit limit

Prudent Control and Compliance

The Internal Control Functions

  1. Compliance with directives and policies
  2. Devise and put in place controls monitor performance against contracts
  3. Ensure security of company assets
  4. Dealing and settlement functions operate efficiently
  5. Satisfy management and regulators that records are accurately kept

Conflicts of interest

  • Staff cannot have any other vested interest in other institutions or in trading instruments for their own gains

Chinese Wall

  • To minimize risk
  • Two sets of Nostro accounts

Insider Dealing

  • Staff operate with the highest integrity and are worthy of trust entrusted to them by clients
2 Responses to “Yield Curves/Managing Money Market Portfolios/Risk Management”
  1. Learn something new everyday\Well thought out post\Thought I would drop in for a quick comment. Been lurking around on your blog for some time now…
    Just thought I would throw a reply on one of your posts to let you know I exist :)

Check out what others are saying...

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: