Asset Liability Management and Hire-Purchase Techniques

Asset Liability
Management and
Hire-Purchase
Submitted By:
Nikhil Khati (99)
Divya Joshi (107)
Ridhima Makkar (109)
Rituparna Sarangi (112)
Shashank Gawalee (113)
Sumkit Paharia (114)

Asset Liability Management
(ALM)
 It is a risk management technique designed
to earn an adequate return while maintaining
a comfortable surplus of assets beyond
liabilities.
 It defines management of all assets and
liabilities (both off and on balance sheet
items) of a bank. It requires assessment of
various types of risks and altering the asset
liability portfolio to manage risk.
 Also called surplus management.

Function of ALM
 To measure and control three levels of
financial risk:
 Interest Rate Risk (the pricing
difference between loans and deposits),
 Credit Risk (the probability of default),
 Liquidity Risk (occurring when loans
and deposits have different maturities).

Primary Objective
 Managing Net Interest Margin that is, the net
difference between interest earning assets
(loans) and interest paying liabilities
(deposits) to produce consistent growth in
the loan portfolio and shareholder earnings,
regardless of short-term movement in
interest rates.

ALM Objectives
 Establish a comprehensive risk management
system.
 Identify the sources of requisite information
for ALM process.
 Identify and define the strategies for
management of market risks.
 Develop new products as risk hedging
techniques

ALM Models
 Gap Analysis
 Duration Gap Analysis
 VAR
 Simulation

Gap Analysis
 Simple to use
 Interest rate risk arises in bank operations because
banks' assets and liabilities generally have their
interest rates reset at different times.
 The magnitude of interest rate risk depends on the
degree of mismatch between the times when asset and
liability interest rates are reset.
 A maturity gap is calculated for a given time period
and includes all fixed-rate assets and liabilities that
mature in that period and all floating-rate assets and
liabilities that have interest rate reset dates in that
period.

Gap Analysis
 A bank that has a positive gap will see its
interest income rise if market interest rates rise,
since more assets than liabilities will exhibit an
increase in the interest rate.
 Drawbacks
 Not usable in conjunction with income statement
analysis.
 Time value of money isn’t taken into account.

Duration Gap Analysis
 Measures the impact of changes in interest
rates on the expected maturities of both assets
and liabilities.
 Converts that information into present-value
worth of deposits and loans, which is more
meaningful in estimating maturities and the
probability that either assets or liabilities will
reprice during the period under review.

Value At Risk (VAR)
 It measures market or economic value risk.
 It is an overall indicator of loss likelihood that
computes the maximum loss over a chosen
horizon at a selected level of probability
(confidence level).
 It’s major feature is that it takes portfolio
diversification between risk factors into
account.

Value At Risk (VAR)
 It simulates hundreds or thousands of times the next
day value change in each instrument for each risk
factor relative to the current risk factor values,
classes the changes by order of magnitude, then
determines the maximum expected loss.
 To integrate the correlation between risk factors, the
variance/covariance matrix is used to convert the
random risk factor changes to a set of correlated
changes by pre-multiplying the vector of changes
by the square root of the variance/covariance
matrix.

Simulation
 This modeling is also referred to as a stochastic
approach because the interest rate paths that it
generates are based on a random-number generator.
The method generates a large number of arbitrage-
free interest rate paths, reevaluates the balance sheet
and income value for each path and then presents
the Asset & Liability Manager with a view of the
values distribution and probability of occurrence.
 Useful for analysing mortgage prepayment options

Problems with Simulation
 Lack of historical data on customer
behaviour still made modeling unreliable.
 Additionally, lack of on-going data storage
made back testing the models difficult.

Hire-Purchase
 It is the legal term for a conditional sale
contract
 Under a hire-purchase agreement you hire
the goods unless and until you exercise the
option to purchase them at the end of the
agreement. This means that, as you don't
own the goods, you can't sell them and must
comply with the terms and conditions set out
in the hire-purchase agreement.

Advantages
 When a sum equal to the original full price plus
interest has been paid in equal installments, the
buyer may then exercise an option to buy the goods
at a predetermined price (usually a nominal sum) or
return the goods to the owner.
 If the buyer defaults, the owner can repossess the
goods (differentiation of HP from other unsecured
consumer credit systems and benefits the economy
because markets can expand while minimizing the
seller's exposure to risk of default.)

Advantages
 HP is advantageous both
 To private consumers because it spreads the
cost of expensive items over an extended time
period.
 To certain business consumers in that the
balance sheet and taxation treatment of hire
purchased goods differs from outright capital
purchases.
 The need for HP is reduced when consumers have
collateral or other forms of credit are readily
available.

HP Agreement
 A clear description of the goods
 The cash price for the goods
 The HP price, i.e., the total sum that must be paid to
hire and then purchase the goods
 The deposit
 The monthly installments (most states regulate the
rates and charges that can be applied in HP
transactions)
 A reasonably comprehensive statement of the parties'
rights (including the right to cancel the agreement
during a "cooling-off" period).

The seller and the owner
 If the seller has the resources and the legal
right to sell the goods on credit (which
usually depends on a licensing system in
most countries), the seller and the owner will
be the same person.
 The seller transfers ownership of the goods
to a Finance Company, usually at a
discounted price, and it is this company that
hires and sells the goods to the buyer.

Implied warranties and conditions
 The hirer will be allowed to enjoy quiet
possession of the goods.
 What is actually supplied must correspond
with the description and the sample.
 If goods are misdescribed or faulty, you have
a direct cause of action against the hire-
purchase company (Supply of Goods (Implied
Terms) Act 1973).

 If, prior to signing the HP agreement, the
dealer/shop made a false claim about the goods, you
may be entitled to end the hire-purchase agreement
and/or recover compensation from the HP company
(section 56 Consumer Credit Act).
 If the dealer/shop gave you a false assurance about
a financial-related matter under the HP agreement
You'll have no cause for complaint if the written
agreement which you signed sets out accurately the
necessary financial details.

 The hire-purchase company can always sue
you for any arrears, but a prior notice of
default is compulsory.
 If, with extra time, you'll be able to make
the repayments, apply to the court for a time
order if, and when, you're served with a
notice of default.

Hirer’s rights
 Buy the goods at any time by giving notice to the
owner and paying the balance of the HP price less a
rebate
 Return the goods to the buyer — this is subject to
the payment of a penalty to reflect the owner's loss
of profit but subject to a maximum specified in each
state's law
 With the consent of the owner, to assign both the
benefit and the burden of the contract to a third
person.

Hirer’s obligation
 To pay the hire installments
 To take reasonable care of the goods (if the
hirer damages the goods by using them in a
non-standard way, he or she must continue
to pay the installments and, if appropriate,
compensate the owner for any loss in asset
value)
 To inform the owner where the goods will
be kept.

Owner’s rights
 To forfeit the deposit
 To retain the instalments already paid and
recover the balance due
 To repossess the goods (which may have to
be by application to a Court depending on
the nature of the goods and the percentage
of the total price paid)
 To claim damages for any loss suffered.

Asset Liability Management and Hire-Purchase Techniques

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Asset Liability Management and Hire-Purchase Techniques