What's new in the 2007 edition



Yield Curve Twist Wizard and Risk to Earnings/Capital Calculations in the

PROFITstar® and PROFITability® Programs

Modeling Non-Parallel Key Rate Movement to Improve Risk Analysis

Date created: Oct 25, 2007

Last updated: Oct 30, 2007

Intended audience: PROFITstar and PROFITability end users

This document is available in electronic form at:



Summary

Effective with PROFITstar and PROFITability version 2007a, a new feature called Yield Curve Twist Projection Wizard has been introduced. The Yield Curve Twist Projection Wizard improves the ease and speed of modeling non-parallel rate changes to a Yield Curve. This enhancement makes incorporating Earnings at Risk and Capital at Risk calculations using non-parallel rate movements a realistic addition to your overall risk management plan.

Details

Over the last few years, there has been increased regulatory pressure on institutions to begin modeling the “twisting” of yield curves for Risk to Earnings (IRSA) and Risk to Capital (Fair Value) calculations. In addition to the pressure from regulators, management should recognize the value of assessing the impact to earnings and capital in various rate environments.

Yield Curve Twist modeling allows you to calculate risk on a projected balance sheet against non-parallel rate movements.

The standard shock calculations in IRSA and Fair Value are based on parallel rate movements. IRSA and Fair Value are calculated based on +/- 100, 200 & 300 bp rate movements.

Parallel rate movement is pictured in this graph.

But as we see below, the Yield Curve does not always move in a parallel manner.

This graph represents the Treasury Yield Curve rates and their movements from June 2004 to June 2005. Short-term rates were on the rise while long-term rates were falling. This resulted in a “flattening” of the Treasury Yield Curve over that 12 month time period. (Spread between short-term and long-term rates changed from 4.01 to 1.31.)

If pricing on 50% of your loan portfolio was tied to the short end of the Treasury Yield Curve and pricing on the other 50% of the loan portfolio was tied to the long end of the Treasury Yield Curve, IRSA and FV results for a parallel, +100 bp shock, (red line), would give you one picture of your risk profile.

Those results could be significantly different than the results of IRSA and FV calculations that used the actual Treasury Yield Curve rates from June 2005.

Modeling multiple parallel and non-parallel rate movements for the Treasury Yield Curve allows you to analyze multiple IRSA and FV results. This could give you a more accurate picture of your overall risk exposure and how your exposure may change when rates move in a parallel manner versus when their movement is non-parallel.

With the addition of the Yield Curve Twist Wizard, the modeling of non-parallel rate movements for projected Yield Curves has been simplified; allowing you to more quickly and easily, model multiple “possible” Yield Curve shapes. IRSA and Fair Value can then be calculated for each of those projected rate environments. This may help you to identify areas of exposure that exist in one rate environment but not in another. Steps can then be taken to minimize your overall risk exposure, for all possible future rate environments.

The calculation of IRSA and Fair Value for non-parallel or “Twisted” Yield Curve environments in not intended to replace the “standard,” parallel rate shocks you are currently doing on a monthly basis. Instead, it is recommended that these calculations be done in addition to what you are already doing.

Recorded Tutorials have been created for Yield Curve modeling, the Yield Curve Twist Wizard, and IRSA/FV calculations using a “Twisted” Yield Curve shape. These are available from the FAQ section of the ProfitStars website or from HELP in the PROFITstar or PROFITability programs.

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ProfitStars - A Jack Henry Company • 2110 Papillion Pkwy, Suite 110 • Omaha, NE • 800.356.9099 • FAX 402.431.8822

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