Literature Review Essay:
· You are required to write a Literature Review of 2,500 words (excluding the references, tables, figures and notes) related to the following topics.
Changes in banks’ competitive environment, products, and services have heightened the importance of prudent interest rate risk management. Historically, the interest rate environment for banks has been fairly stable, particularly in the decades following World War II. More recently, interest rates have become more volatile, and banks have arguably become more exposed to such volatility because of the changing character of their liabilities. ‘The level and volatility of interest rates and the increase in worldwide financial market integration make the measurement and management of interest rate risk one of the key issues facing financial institutions’ managers.’ (Saunders and Cornett, 2014, p199)
Evaluate the above statement by fully discussing:
a. What the causes/sources of interest rate risk (IRR) are
b. How IRR affects financial institutions
c. How to measure and manage IRR by financial institutions
To address Question C, try to discuss and compare the use of traditional GAP management and financial derivatives (e.g., forwards, futures, swaps and options) to manage IRR. Discussions may include:
· How it works?
· Advantages and disadvantages of each method?
1. To answer these it is recommended you read the following papers:
a. Bank for International Settlements, 2004, Basel Committee on Banking Supervision: Principles for the Management and Supervision of Interest Rate Risk – Final Document, BIS, July 2004.
b. Beets, S., 2004, The Use of Derivatives to Manage Interest Rate Risk in Commercial Banks, Investment Management and Financial Innovations, 2: 60 – 74.
c. Sharifi, O., Saeidi, M. and Saeidi, H., 2014, Interest Rate Risk Management Using Income and Duration Gap Analysis in Banks – An Empirical Study, MAGNT Research Report, 2 (7): 3058 – 3071.
2. For Paper A, you should emphasise on Section I-Sources and Effects of Interest Rate Risk. The rest of sections are related to regulatory issues that are not central to the module.
3. For Paper B, you should understand how to use derivatives to manage IRR and associated benefits and weaknesses in general terms. You don’t need to understand all the detailed formulae in relation to derivatives.
· Each of these papers can be found and downloaded either by Google or by LibrarySearch.
· You are expected to link your answers together in the form of a single essay.
· You should also refer to further articles in relation to this topic.
· All articles should be correctly cited and referenced (including those provided above) following APA Referencing (available in the Coursework folder on Moodle)