Download investment management of banks

INVESTMENT MANAGEMENT OF BANKS
OBJECTIVES
•
•
•
•
•
Stabilize Bank’s Income
Offset Credit Risk Exposure
Usage as Collateral
Flexible Asset Composition
Enhance Liquidity
PORTFOLIO INVESTMENT
• When deposits are low and loan demand is high
– Use investments as collateral and borrow and utilize
this to meet loan demand
– Sell investments to meet loan demand
PORTFOLIO INVESTMENT
• When deposits are high and loan demand is weak
– Use investments to increase earnings capacity of
banks
– Retrieve pledged investments to convert it into an
earning asset
FACTORS AFFECTING PORTFOLIO
INVESTMENT
• Return
• Risk
• Tax
INVESTMENT PORTFOLIO OF A BANK
I Investments in India in
Government Securities.
157738,10,12
143727,26,29
Other approved securities
4194,47,61
4527,26,17
Shares
901,89,75
992,52,85
Debentures and Bonds
15874,94,56
16166,26,61
Subsidiaries and/or joint ventures
1436,03,94
1189,49,38
Others (Units / Commercial
Papers etc.)
1538,90,23
1282,79,48
TOTAL 181684,36,21
167885,60,78
Reference: http://www.rbi.org.in/scripts/PublicationsView.aspx?id=13895
Continued..
INVESTMENT PORTFOLIO OF A BANK
II Investments outside India in
Government securities (including
local authorities)
202,93,60
381,38,12
Subsidiaries and/or joint ventures
abroad
276,73,05
216,32,44
Other investments (Shares,
Debentures etc.)
3512,45,42
3864,59,38
GRAND TOTAL
3992,12,07
4462,29,94
INVESTMENTS OF SCHEDULED
COMMERCIAL BANKS
Items
Year 1
Amount Per
share
cent
(1)
(2)
657606 97.8
Investments by offices in
India
A. Indian Government
502498
Securities
1 Central Government 423089
2
3
State Governments 78505
Others *
904
(Amount in Rs. crore)
As on March 31
Year 2
Year 3
Amount
Per
Amount
Per
share
cent
share
cent
(3)
(4)
(5)
(6)
767874
98.3
837559
98.4
74.8
584422
74.8
653496
76.7
62.9
475521
60.8
538091
63.2
11.7
0.1
107253
1648
13.7
0.2
115216
189
13.5
0
Continued..
INVESTMENTS OF SCHEDULED
COMMERCIAL BANKS
Items
B. Other domestic securities,
(Amount in Rs. crore)
As on March 31
Year 1
Year 2
Year 3
Amount Per Amount Per Amount Per
share
cent share cent share
cent
153967 22.9 180326 23.1 183246 21.5
bonds, shares, etc.
1 Other trustee securities 20459
(excluding units of UTI)
12472
2 Fixed Deposits
3 Shares and Debentures of 103470
Joint Stock Companies
(market value)
3
20502
2.6
18865
2.2
1.9 19127 2.4 19631 2.3
15.4 105635 13.5 103531 12.2
Continued..
INVESTMENTS OF SCHEDULED
COMMERCIAL BANKS
Items
4
5
6
7
8
Initial contribution to
Share
Capital of UTI
Units of UTI
Certificate of Deposits
and
Commercial Papers
Mutual Funds
Others @
(Amount in Rs. crore)
As on March 31
Year 3
Year 1
Year 2
Amount Per Amount Per Amount Per cent
share
cent share
cent share
70
0
1
0
4
0
283
2940
0
0.4
17
2296
0
0.3
19
3450
0
0.4
5246
9027
0.8
1.3
9545
23203
1.2
3
10480
27266
1.2
3.2
Continued..
INVESTMENTS OF SCHEDULED
COMMERCIAL BANKS
Items
(Amount in Rs. crore)
As on March 31
Year 1
Year 3
Year 2
Amount Per Amount Per Amount Per cent
share cent share
cent share
C. Foreign Securities 1141
1Foreign
Governments’
Securities
2Other Foreign
Investments
77
0.2
0
3126
82
0.4
0
817
—
0.1
0
1064
0.2
3044
0.4
817
0.1
Continued..
INVESTMENTS OF SCHEDULED
COMMERCIAL BANKS
Amount in Rs. Crore
Items
Year 1
Amount Per cent
share
Investments by Foreign
Offices of Indian Banks
1 Indian Securities
2 Foreign Countries
Securities
3 Other Investments
Total
As on March 31
Year 2
Year 3
Amount
share
Per cent
Amount
share
Per cent
14558
2.2
13621
1.7
13995
1.6
0
3213
0
0.5
—
2920
0
0.4
—
3353
0
0.4
11345
672164
1.7
100
10701
781495
1.4
100
10642
851554
1.2
100
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Ratios
As on March 31
State
State Bank of
State
State
Bank of
Bikaner
Bank of
Bank of
India
& Jaipur
Hyderabad
Indore
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
53.7 42.77 43.92 36.57 50.33 41.9 42.72 30.68
Investmentdeposit ratio
Return on
8.37
investments
Return on
3.48
investments
adjusted to cost
of funds
7.77
9.49
8.85
7.82
8.21
8.01
7.76
3.03
4.68
4.38
2.96
3.22
3.47
3.25
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Ratios
As on March 31
State
State Bank of
State
State
Bank of
Patiala
Bank of
Bank of
Mysore
Saurashtra
Travancore
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
42.67 34.78 46.47 38.08 48.25 42.81 43.89 40.89
Investmentdeposit ratio
Return on
8.57
investments
Return on
3.87
investments
adjusted to cost
of funds
7.66
7.85
7.11
9.7
9.11
8.58
8.47
3.15
3.23
2.45
4.76
4.23
3.82
3.59
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Ratios
Allahabad
Bank
As on March 31
Andhra Bank
Bank of
Baroda
Bank of
India
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
46.6 37.1 38.64 33.74 45.6 37.49 36.39 33.83
Investmentdeposit ratio
Return on
8.47
investments
Return on
3.58
investments
adjusted to cost
of funds
8.05
7.85
7.16
7.96
8.19
7.62
7.15
3.31
3.41
2.59
3.78
4.16
3.33
2.97
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Ratios
As on March 31
Bank of
Canara Bank
Central
Corporation
Maharashtra
Bank of
Bank
India
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
50.2 42.2 39.31 31.66 50.76 43.08 37.68 32.4
Investmentdeposit ratio
Return on
8.89
investments
Return on
3.91
investments
adjusted to cost
of funds
8.52
8.28
7.61
8.59
8.61
8.4
8.16
3.64
3.67
3.04
3.96
4.08
4.2
3.89
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Dena
Bank
Ratios
As on March 31
IDBI Ltd.
Indian Bank
Indian Overseas
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
46.4
36.3
165.9 97.5
51.48 46.6
42.98 37.51
Investmentdeposit ratio
Return on
8.35
investments
3.39
Return on
investments
adjusted to cost
of funds
7.82
1.58
3.35
8.33
8.27
9.04
8.81
3.4
0.96
1.77
3.68
3.66
4.4
4.16
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Oriental
Bank
Ratios
As on March 31
Punjab & Sind
Punjab
Bank
National Bank
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
38.33 33.5
49.97 41.1
49.12 34.3
Investmentdeposit ratio
Return on
9.52
investments
4.85
Return on
investments
adjusted to cost
of funds
Syndicate Bank
Year 1 Year 2
44
32.2
9.19
8.82
8.36
8.56
8.79
8.2
6.43
4.26
4.16
4.26
4.25
4.76
3.7
2.33
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Ratios
As on March 31
UCO
Union Bank of
United
Vijaya
Bank
India
Bank of
Bank
India
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
38.5
36
36.86 34.98 56.82 48.31 47.11 40.35
Investmentdeposit ratio
Return on
8.08
investments
Return on
3.47
investments
adjusted to cost
of funds
8.05
8.33
8.02
8.7
8.17
7.82
8.02
3.04
3.59
3.41
3.73
3.45
3.32
3.38
Continued..
INVESTMENT PERFORMANCE OF
BANKS
(in per cent)
Ratios
As on March 31
ABN Amro
Abu Dhabhi
American
Antwerp
Bank
Bank
Express
Diamond Bank
Bank
Year 1 Year 2 Year 1 Year 2 Year 1 Year 2 Year 1 Year 2
47.4
40.67 75.63 30.98 45.83 43.83 327.9 266.36
Investmentdeposit ratio
Return on
7.91
investments
4.97
Return on
investments
adjusted to cost
of funds
8.03
9.37
11.79
4.69
4.36
7.89
6.98
4.25
1.71
3.28
-0.88
-1.36
6.18
3.22
Continued..
YIELD CURVE
• Yield curve is a graph that depicts the relationship
between bond yields and maturities.
• Investors use the yield curve as a reference point for
forecasting interest rates, pricing bonds and creating
strategies for increasing total returns.
• Yield curve is a leading indicator of economic activity.
CONTENTS OF THE YIELD CURVE
• Yield on a bond is based on both the purchase price of
the bond and the interest or coupon payments received.
• Yield curve is a line graph that plots the relationship
between yields to maturity and time to maturity for bonds
of the same asset class and credit quality.
• The plotted line begins with the spot interest rate, which
is the rate for the shortest maturity, and extends out in
time, typically to 30 years.
7.268462082
6.750656082
6.232850082
5.715044082
5.197238082
4.679432082
4.161626082
3.643820082
3.126014082
Maturity in years
Source: http://www.nseindia.com/content/debt/debt_zcyc.htm,
Accessed on 15 December 2010.
19.69580608
9
19.17800008
18.66019408
18.14238808
17.62458208
17.10677608
16.58897008
16.07116408
15.55335808
15.03555208
14.51774608
13.99994008
13.48213408
12.96432808
12.44652208
11.92871608
2-Nov-07
11.41091008
10.89310408
10.37529808
9.857492082
9.339686082
8.821880082
8.304074082
7.786268082
7.67
2.608208082
7
2.090402082
7.67
1.572596082
8
1.054790082
0.536984082
0.019178082
Spot interest rates
ZERO COUPON YIELD CURVE
Source: “www.nseindi.com
Plot of the Estimated ZCYC
5-Nov-07
12
11
10
8.41
8.38
6
5
4
3
IMPLICATIONS OF RATE OF INTEREST
• Yield curve depicts yield differences or yield spreads,
that are due to differences in maturity.
• This relationship between yields and maturities is known
as the term structure of interest rates.
• The normal shape or slope of the yield curve is upward,
which means that bond yields usually rise as maturity
extends.
THEORIES ON YIELD CURVE
• Pure Expectations Theory: The theory holds that the
slope of the yield curve reflects only investors’
expectations for future short-term interest rates. Mostly
investors expect interest rates to rise in the future, which
accounts for the usual upward slope of the yield curve.
Continued..
THEORIES ON YIELD CURVE
• Liquidity Preference Theory: Here long-term interest rates
not only reflect investors’ assumptions about future interest
rates but also include a premium for holding long-term bonds,
called the term premium or the liquidity premium. This
premium compensates investors for the added risk of having
their money tied up for a longer period. Because of the term
premium, long-term bond yields tend to be higher than shortterm yields, and the yield curve slopes upward.
Continued..
THEORIES ON YIELD CURVE
• Preferred Habitat Theory: In addition to interest rate
expectations, investors have distinct investment horizons
and require a meaningful premium to buy bonds with
maturities outside their preferred maturity or habitat.
Proponents of this theory believe that short-term
investors are more prevalent in the fixed-income market
and therefore, longer-term rates tend to be higher than
short-term rates.
SHARP UPWARD YIELD CURVE
• A sharply upward sloping or steep yield curve, has often
preceded an economic upturn. The assumption behind a
steep yield curve is interest rates will begin to rise
significantly in the future. Investors demand more yield
as maturity extends if they expect rapid economic growth
because of the associated risks of higher inflation and
higher interest rates.
FLAT YIELD CURVE
• A flat yield curve signals an economic slowdown. The
curve flattens when the interest rates rise to restrain a
rapidly growing economy.
• Short-term yields rise to reflect the rate hikes, while longterm rates fall as expectations of moderate inflation
prevails.
• A flat yield curve is unusual and indicates a transition to
either an upward or downward slope.
INVERTED YIELD CURVE
• An inverted yield curve can signal recession.
• When yields on short-term bonds are higher than those
on long-term bonds, it suggests that investors expect
interest rates to decline in the future, usually in
conjunction with a slowing economy and lower inflation.
YIELD CURVE
YIELD CURVE
Future short-term
interest rates will be
higher.
Investment managers
will use this
information by shifting
their investments
away from long-term
securities and towards
short-term securities.
YIELD CURVE
Future short-term interest
rates will be lower.
Investment managers will
use this information by
shifting their investments
away from short-term
securities and towards
long-term securities.
RIDING THE YIELD CURVE
• When the yield curve slopes upward, as a bond
approaches maturity or “rolls down the yield curve”, it is
valued at successively lower yields and higher prices.
• Using this strategy, a bond is held for a period of time as
it appreciates in price and is sold before maturity to
realize the gain. As long as the yield curve remains
normal or in an upward slope, this strategy can
continuously add to total return on a bond portfolio.
INVESTMENT MATURITY STRATEGIES
• Ladder or Spaced Maturity Policy
• Front end Load Maturity Policy
• Back end Load Maturity Policy
• Barbell Investment Portfolio Strategy
• Rate Expectations Strategy
LADDER OR SPACED MATURITY POLICY
LADDER OR SPACED MATURITY POLICY
• Equal percentage of investments over short and long
term maturing securities
• Difficulty in finding good credit rated securities in all
maturity profiles
• Cost of building the investment policy is high
FRONT END LOAD MATURITY POLICY
FRONT END LOAD MATURITY POLICY
• All investments are made in short-term maturity
securities
• Persistent revision of portfolio is required
• Policy will be successful only in liquid markets
BACK END LOAD MATURITY POLICY
BACK END LOAD MATURITY POLICY
• All investments are long-term maturity securities
• Policy is subject to price and rate sensitiveness
• Inflation risk is also to be borne by this policy
BARBELL INVESTMENT PORTFOLIO
STRATEGY
BARBELL INVESTMENT PORTFOLIO
STRATEGY
•
A balanced holing of short and long term maturity securities.
•
A bond investment strategy in which the maturities of the securities
included in the portfolio are concentrated at two extremes.
•
Barbell strategy involves selecting only bonds with short and long
term maturities.
•
The maturity structure of the portfolio can be lengthened or shorted
by varying the amount of securities on either end of the maturity
range.
BARBELL INVESTMENT PORTFOLIO
STRATEGY
•
Using this approach requires constant attention from the portfolio
manager.
•
Bonds with short maturities need to be rolled over into new short
term securities as they reach maturity. As long term bonds reach
middle maturity, they have to be rolled over into new long term
securities.
•
One disadvantage to a barbell strategy is its transaction costs. In
addition, long term bonds are much more sensitive to interest rate
changes. Therefore, the long term maturity side of the portfolio tends
to have greater volatility than the short term maturity side.
ACTIVE INVESTMENT STRATEGIES
• Speculative strategies
– Bond Swaps
• Rate Anticipation Swaps,
• Quality Swaps,
• Yield Pick-Up Swaps.
– Yield Curve Strategies.
• Shift Strategies
– Ladder Strategy
– Bullet Strategy
– Barbell Strategy
RATE EXPECTATIONS STRATERGY
RATE EXPECTATION
• Strategy of buying bonds with high or low durations
based on the expectation of an upward or downward
parallel shift in the yield curve. It is a type of yield curve
shift strategy.
Expected in interest rates - Buy Short duration Investments
Expected in interest rates - Buy Long duration Investments
QUALITY SWAPS
• Strategy of buying investments with high or low quality
rating based on the expectation of a change in economy.
Expect Economic Recession – Buy High quality investments;
Sell low quality investments
Expect Economic Expansion – Buy low quality investments;
Sell high quality investments
YIELD PICK UP SWAP
• Strategy of identifying investments which are identical
but do not yield the same rates. The assumption is that
the return on the investments will eventually converge.
Among identical investments
(same quality, same maturity)
Buy the under priced security
Sell the overpriced security
TYPES OF YIELD CURVE SHIFTS
• Parallel Shifts: Rates on all maturities change by the
same number of basis points (or by the same
percentage).
• Flattened Twisting: The difference in the yield to maturity
of long term instruments to the yield to maturity of short
term instruments are declining (YTMLT – YTMST).
• Steeped Twisting: The difference in the yield to maturity
of long term instruments to the yield to maturity of short
term instruments are increasing (YTMLT – YTMST).
TYPES OF YIELD CURVE SHIFTS
• Positive Humped Shift: Short term and long term rates
change more than intermediate interest rates.
• Negative Humped Shift: Intermediate maturity interest
rates change more than short term and long term rates
of interest.
BULLET STRATEGY
• Portfolio of investments concentrated in one maturity
area. All investments are heaped as a 5 year or a 3 year
or any other specific maturity investment or around this
short or long term maturity.
• Example: 40% of the investment portfolio would have 4.5
years as maturity, 35% would have a maturity of 5 years
and the remaining 25% of the investment portfolio would
be having a maturity of 5.5 years.
TOTAL RETURN ANALYSIS
• Total return analysis involves determining the possible
returns from different yield curve strategies given
different yield curve shifts.
CASE ANALYSIS
• Consider three bonds:
– Investment A: 5-year, 8% bond selling at par.
– Investment B:15-year,10% bond selling at par.
– Investment C: 10-year, 9% bond selling at par.
• Two Possible Strategies:
– Barbell: Invest 50% in A and 50% in B.
– Bullet: 100% in Bond C.
YIELD CURVE SHIFTS
• Case 1 : Parallel Shifts
– A rate change of 50 basis points
• Case 2: Flattened Twist
– C increases by 25 points, A increases by 50 basis points and B
increases by 10 basis points
• Case 3: Steep Twist
– C increases by 25 points, A increases by 10 basis points and B
increases by 50 basis points
• Case 4: Positive Hump
– C increases by 25 basis points, A and B increases by 50 basis
points
• Case 5: Negative Hump
– A and B increases by 25 basis points, C increases by 50 basis
points
COMPUTATION OF CASE 1
• Investment A
Time
1
2
3
4
Interest Rate
8
8
8
8
Discount at
changed rate
0.921659
0.849455
0.782908
0.721574
0.665045
Discounted
Value
7.373272
6.795642
6.263265
5.772594
71.82491
Interest Income
Asset Appreciation/Depreciation (Value-100)/100
Total Return
0.085
5
108 Total Value
98.02968
0.085
-0.0197
0.065297
RETURN ANALYSIS
Case 1
A
C
B
Barbell
Rates
8.5
Value
98.02968
Return
0.065297 0.063606 0.068031 0.063606 0.066664
Case 2
Rates
A
9.5
Bullet
96.8606 96.30309
C
8.5
10.5
B
9.25
10.1
Value
98.02968 98.41309 99.24371
Return
0.065297 0.076631 0.093437 0.076631 0.079367
Continued..
RETURN ANALYSIS
Case 3
A
Rates
C
8.1
B
9.25
Bullet
Barbell
10.5
Value
99.60178 98.41309 96.30309
Return
0.077018 0.076631 0.068031 0.076631 0.072524
Case 4
Rates
A
C
8.5
B
9.25
10.5
Value
98.02968 98.41309 96.30309
Return
0.065297 0.076631 0.068031 0.076631 0.066664
Continued..
RETURN ANALYSIS
Case 5
A
C
B
9.5
Bullet
Barbell
Rates
8.25
10.25
Value
99.00837
Return
0.072584 0.063606 0.083753 0.063606 0.078168
96.8606 98.12531
INTEREST RATES RISE
Case 1
A
C
B
Barbell
Rates
8.5
Value
98.02968
Return
0.065297 0.063606 0.068031 0.063606 0.066664
Case 2
Rates
A
9.5
Bullet
96.8606 96.30309
C
8.5
10.5
B
9.25
10.1
Value
98.02968 98.41309 99.24371
Return
0.065297 0.076631 0.093437 0.076631 0.079367
Continued..
INTEREST RATES RISE
Case 3
A
Rates
C
8.1
B
9.25
Bullet
Barbell
10.5
Value
99.60178 98.41309 96.30309
Return
0.077018 0.076631 0.068031 0.076631 0.072524
Case 4
Rates
A
C
8.5
B
9.25
10.5
Value
98.02968 98.41309 96.30309
Return
0.065297 0.076631 0.068031 0.076631 0.066664
Continued..
INTEREST RATES RISE
Case 5
A
C
B
9.5
Bullet
Barbell
Rates
8.25
10.25
Value
99.00837
Return
0.072584 0.063606 0.083753 0.063606 0.078168
96.8606 98.12531
TOTAL RETURN ANALYSIS
• Parallel Shifts:
– For rate increases, the barbell strategy gives best
results.
– For rate declines the bullet strategy gives best results.
• Flattening:
– For rate increases, the barbell strategy gives best
results.
– For rate declines the bullet strategy gives best results.
• Steepening:
– For rate increases, the bullet strategy gives best
results.
– For rate declines the barbell strategy gives best
results.
Continued..
TOTAL RETURN ANALYSIS
• Positive Hump:
– For rate increases, the bullet strategy gives best
results.
– For rate declines the barbell strategy gives best
results.
• Negative Hump:
– For rate increases, the barbell strategy gives best
results.
– For rate declines the bullet strategy gives best results.