R20 : Leverage-Adjusted Duration Gap overall, interest, positive

RoastBeef

CFAI Text Vol 2, P419 (Reading 20). It is stated :

LADG (Leverage-Adjusted Duration Gap) meaures a bank's overall interest rate exposure.

What does a positive/negative LADG mean ? Is a positive/negative LADG favorable or unfavorable ?

Can anyone help ?

PalacioHill

That's explained on the CFAI text.

It depends whether interest rates rise or fall. If the gap is positive and interest rates are rising, assets will fall more than liabilities, so it's negative. But if interest rates are falling, then assets will rise more than liabilities, so positive.

skycfa

Sorry, I now know that LADG is just same as the "DURATION" of the net worth (equity). If I/R increases, market value of net worth will decrease. If I/R decreases, market value of net worth will increase. That's all.

lcw77

Footnote 32 at the bottom of P419.

Shall "the change in the MV of net worth for an I/R shock is approximately equal to the "Dollar Duration" of net worth (LADG x NET WORTH of the bank x size of the I/R shock) ? Why "MV of ASSETs" is used to approximate the change in the MV of net worth ?

Windjam

DD = A*Dur(Asset) - L*Dur(Liability)

LADG = Dur(Asset) - (L/A)*Dur(Liability)

bpdulog

deriv108 Wrote:
-------------------------------------------------------
> DD = A*Dur(Asset) - L*Dur(Liability)
> LADG = Dur(Asset) - (L/A)*Dur(Liability)

LADG is the duration of NET WORTH (Asset - Liability), so
change (%) in the MV of net worth for an I/R shock
= DOLLAR DURATION of NET WORTH
= LADG x NET WORTH of the bank x size of the I/R shock (%)

Please correct me if I am wrong.

nannan66

I couldn't find out in curriculum, but Schweser says "LADG is a measure of the duration of bank's equity".

To calculate the duration dollar, we can get it directly: DD= [A*Dur(Asset) - L*Dur(Liability) ]*0.01, which is LADG*A*0.01 as you've shown.

I understand your question, so LADG is not exactly the duration of net worth(A-L). And it's not the duration of asset, either.

The duration of net worth(A-L) might be like (A/E)*Dur(Asset) - (L/E)*Dur(Liability). But LADG does look simpler.

aidebaobao

IMHO What is a "regular" Duration Gap if this is a "Leverage-Adjusted" Duration Gap? A
"regular" gap should be the difference between a measure of the Duration of the Assets and the Duration of the Liabilities. Makes sense. (Da-Dl) seems like a logical elementary formula for a gap of duration if the only holdings of a company are the assets and the liabilities. If you want to calculate DD you can include and multiply by the .01 but this post is about LADG.

If you want to calculate the "Leverage-Adjusted" duration gap, you adjust for leverage on the duration gap. CFAI uses "k" as the "Leverage-Adjuster." The Leverage Adjuster is L/A. CFAI says LADG is then equal to Da-kDl. Where k= L/A. So LADG= Da-(L/A)Dl

IMHO CFAI wants us to be able to calculate a banks LADG and determine what type of interest rate risk they are exposed to and whether their NW is improved or worsened by either an increase or decrease in interest rates. If the gap is positive, the Duration of Assets is higher. (I think of this as "Assets are larger in duration so they will fall more than liabilities" for an increase in interest rates. So your Assets (what you own) falls in value more than your Liabilities (what you owe). The net effect is a decrease in NW.

bkballa

"Regular" Dur(NW) or Firm's Duration = (A/E)*LADG.

So a postive LADG means a positive duration of Net Worth. Starting to make sense.

Adjusted for the leverage (A/E), we get LADG.



Edited 1 time(s). Last edit at Tuesday, March 22, 2011 at 04:56PM by deriv108.

lcai

Just to clarify, are you guys assuming that NW or Firm's duration is different from Equity?

Because the way I understand LADG formula is that LADG = duration of bank's equity, without A/E that you guys posted. And because equity value is function of equity duration (LADG) and change in interest rate, and it has inverse relationship, when interest rate increases, positive value of LADG leads to decline in equity value. But when interest rate decreases, positive LADG leads equity value to increases. Am I oversimplifying this?