Alternative Investments Portfolio Management

Alternative Investments Portfolio Management
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Alternative Investments Portfolio Management

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balance sheet management content. Management of the term portfolio is normally a separate function under the FHLBanks treasury function. These portfolios require regular monitoring for performance and do contain interest rate risk. Risks Associated with Investment Securities An FHLBank s primary risks associated with investment securities and money market assets are set forth below. 1 Lack of Sound Corporate Governance Board of Directors and Senior Management Oversight a Key risks and controls are not adequately identified, measured, monitored, and controlled. b A sound risk management framework composed of policies and procedures, risk measurement and reporting systems, and independent oversight and control processes has not been developed and implemented. c Senior management has not adequately analyzed new products or activities, taking into account pricing, processing, accounting, legal, risk measurement, audit, and technology considerations. d Risk management, monitoring, and control functions are not sufficiently independent of the position-taking functions. e Duties, responsibilities, and staff expertise, including segregation of operational and control functions, are not adequately defined. f Independent audit coverage and testing is limited auditors are inexperienced or lack the technical expertise to test the control environment. 2 Market Risk The discussion of market risk will begin with those factors that impact the price sensitivity of a security and then proceed to outline measures of rate sensitivity, both for option-free securities and securities with options. Finally, this section will address portfolio sensitivity measures, risk control of portfolio sensitivity, and asset liability management issues. Factors in Interest Rate Sensitivity The investment portfolio, which often contains longer-term, fixed-rate assets, is usually a significant source of interest rate risk for an FHLBank. From an interest rate risk standpoint, sensitivity refers
FHFB Office of Supervision
Examination Manual April 2007 12.3
to how much the price of a security changes when interest rates change. Regardless of the type of security, it is the variability of the value of the security s cash flow, caused by fluctuating interest rates and spreads relative to a benchmark such as Treasuries, that determines a security s price sensitivity. A security s interest rate, or price sensitivity, is primarily a function of 1 2 3 4
Maturity Option features Coupon rate and Yield levels.
Maturity. For most securities, maturity is the most important determinant of price sensitivity. If a change in interest rates is the same across all maturities, a parallel interest rate shift, the price of a long-term security will change more than the price of a short-term one. For example, if interest rates