Areas covered in this section Why Interest Rate Risk (IRR) should not be ignored • Forward Rate Agreements (FRA’s) Forwards, Futures • Swaps, Options Why Bank Regulators continue to have a poor handle on interest rate risk • Interest Rate Caps, floors, Collars • LIBOR and UBS & Barclays rigging rates • How should Financial Institutions determine which IRR vendor models are appropriate? IRR Measurement methodologies are institutions

1. Interest Rate Risk Management –
What Regulators want in 2015
Thursday, 16 July 2015
11:30 AM PST | 2:30 PM EST
By Craig M. Taggart

2. Learning objectives:
Evaluate the elements necessary for an effective training
program that will define income at risk and differentiate
between the various measurement systems to assess income
at risk. Interest rate risk exists in an interest bearing asset,
such as a loan or a bond, due to the possibility of a change in
the asset’s value resulting from the variability of interest rates.
Interest rate risk management has become very important,
and assorted instruments have been developed to deal with
interest rate risk.

3. Areas Covered in the Session:
• • Why Interest Rate Risk (IRR) should not be ignored
• • Forward Rate Agreements (FRA’s) Forwards,
Futures
• • Swaps, Options
• Why Bank Regulators continue to have a poor handle
on interest rate risk
• • Interest Rate Caps, floors, Collars
• • LIBOR and UBS & Barclays rigging rates
• • How should Financial Institutions determine which
IRR vendor models are appropriate?
• IRR Measurement methodologies are institutions

4. Target Audience
• • Bank and financial institution auditors
• Controllers and corporate managers
• Bank CEO’s , CFO’s and Regulators
• Board Members
• Forensic and management accountants, financial
analysts
• Governance, risk management and compliance officers
• Internal and external auditors
• Community banks and credit unions
• Securities attorneys
• Fraud professionals

5. Instructor Profile
• Craig Taggart has almost a decade of experience in the fields of mergers and
acquisitions and business financing. Mr. Taggart works strategically with his clients to
achieve the highest value for their business within the capital markets. His
experience with BCC Capital Partners in the M&A industry has greatly contributed to
his understanding of transaction structure, strategic
• placement of buyers, and the attainment of maximum market value for his clients.
He has represented and sold many businesses in a number of different industries and
has significant experience working with companies in: continuing education,
transportation, software and professional services. Mr. Taggart is currently working in
the clean energy sector that covers multiple initiatives within M&A and corporate
development.
• He is a certified merger and acquisition advisor, accredited valuation analyst as well
as an active member of Alliance of Mergers and Acquisition, and The National
Association of Certified Valuators and Analysts (NACVA). His knowledge and expertise
also extends to systems such as: Software as a Service (SaaS), and ERP and CRM
systems (Netsuite, Salesforce, Sage 100, 500, X3 ERP). Mr. Taggart has been a
certified fraud examiner since 2011 and has previously worked at Deloitte with their
quality risk management team.
• He earned his MBA from the San Diego State University specializing in financial
management. Mr. Taggart graduated from the California State University Northridge
with a bachelor’s degree majoring in organizational psychology.

6. Regulators in the dark for how long?
• The latest report on risk to the banking sector which is released by
the Office of the Comptroller of the Currency gives a good summary
• The real problem is that the OCC report is 40 pages, with only three
pages devoted to interest rate risk
• The fact is regulators still do not have the data or reporting to
systematically report on interest rate risk profiles of commercial
banks. Continuing to rely on overly simplistic maturity gap
measures and outside vendor’s assessments.
• The inability to build sophisticated analyses of risk sensitivities and
use a more meaningful metric such as duration continues to leave
all of us waking one morning to a major interest rate risk event.
• The OCC is reporting that a 2% increase in rates would lead to a
24% reduction in market value equity or (MVE). This is double what
is was in 2008, the year of the great credit crisis and fall of Lehman
Brothers among others.

7. • With the OCC absorbing the Office of Thrift Supervision in 2012,
these agencies need to develop capabilities to assess this risk with
industry standard methodologies
• In its latest 2014 annual report the Office of Financial Research
cited interest rate risk as a major emerging threat to the financial
system, citing significant gaps in data gathering
• The Fed’s Comprehensive Capital Analysis and Review stress test
process does indeed provide good detailed data on bank positions.
• The current system in place is currently leaving the door wide open
to our next financial crisis due to a lack of a systematic process.
• A real world example of this was the mortgage crisis and bank
regulators have used enormous resources in plugging gaps, on the
financing and servicing side. Many experts have called this similar
revising a building code to allow for greater spacing between
buildings after the Great Chicago Fire!
• Question for webinar attendees? What lessons did we learn from
the great recession and the credit crisis? Are the financial markets
set to collapse again?

8. Types & Charts

9. Types of Interest Rate Risks
• Risk Repricing: Unfortunately, once a market correction
occurs, investors will often realize that they have been
exposed to more risk in certain investments than originally
anticipated. Because higher risk investments yield
potentially higher returns, the market goes through an
adjustment period during which relevant investments will
be repriced to account for the extra risk. Investopedia
• Basis Risk: The risk that offsetting investments in a hedging
strategy will not experience price changes in entirely
opposite directions from each other. This imperfect
correlation between the two investments creates the
potential for excess gains or losses in a hedging strategy,
thus adding risk to the position. Investopedia

10. Types of Interest Rate Risks
• Yield Curve Risk: The risk of experiencing an adverse shift in market
interest rates associated with investing in a fixed income
instrument. The risk is associated with either a flattening or
steepening of the yield curve, which is a result of changing yields
among comparable bonds with different maturities. When market
yields change, this will impact the price of a fixed-income
instrument. When market interest rates, or yields, increase, the
price of a bond will decrease and vice versa. Investopedia
• Embedded Option risk: An embedded option is a component of a
financial bond or other security, and usually provides the
bondholder or the issuer the right to take some action against the
other party. There are several types of options that can be
embedded into a bond. Some common types of bonds with
embedded options include callable bond, puttable bond,
convertible bond, extendible bond, exchangeable bond, and capped
floating rate note. A bond may have several options embedded if
they are not mutually exclusive. Investopedia

11. 3 Sectors That Could Benefit From
Rising Interest Rates
• Consumer Discretionary "The early part of a rate hike
cycle should be beneficial to the consumer discretionary sector.
Higher rates are presumably the result of a pickup in economic
growth that is flowing from higher levels of employment, which
creates a stronger sense of job security, higher wage growth and
increased lending activity, and that leads to higher levels of
spending,"
• Financial "Financials benefit from rising interest rates because the
interest margin expands, creating more profit, and the increased
economic activity that caused the rate hike generally means more loan
demand,"
• Technology Rising yields generally mean that the economy is
improving, which should be good for tech companies that depend on
corporate spending. Think Cisco or Microsoft."

12. UBS & LIBOR
• In May of this year the U.S. Justice Department
announced five of the world’s largest banks will plead
guilty and pay fines of almost $5.8 billion.
• One of those banks UBG AG will plead guilty for
breaching an earlier non-prosecution agreement in
connection with a long-running investigation into
manipulation of the London Interbank Offered Rate
(LIBOR) and other benchmark interest rates. UBS will
pay a $203 million fine
• It has found that “The Cartel” traders allegedly
coordinated their trading of U.S. dollars and euros to
manipulate the benchmark rates set at the 1:15 p.m.
and 4:00 p.m. fixes in an effort to boost their profits.

13. Review of Terms
• Forward Rate Agreement: An over-the-counter
contract between parties that determines the
rate of interest, or the currency exchange rate,
to be paid or received on an obligation
beginning at a future start date. The contract
will determine the rates to be used along with
the termination date and notional value. On
this type of agreement, it is only the
differential that is paid on the notional
amount of the contract. Investopedia

14. • Swap: A swap is a derivative in which two counterparties exchange cash
flows of one party's financial instrument for those of the other party's
financial instrument. The benefits in question depend on the type of
financial instruments involved. For example, in the case of a swap
involving two bonds, the benefits in question can be the periodic interest
(coupon) payments associated with such bonds. Specifically, two
counterparties agree to exchange one stream of cash flows against
another stream. These streams are called the legs of the swap. The swap
agreement defines the dates when the cash flows are to be paid and the
way they are accrued and calculated
• Options: A financial derivative that represents a contract sold by one party
(option writer) to another party (option holder). The contract offers the
buyer the right, but not the obligation, to buy (call) or sell (put) a security
or other financial asset at an agreed-upon price (the strike price) during a
certain period of time or on a specific date (exercise date).
Call options give the option to buy at certain price, so the buyer
would want the stock to go up.
Put options give the option to sell at a certain price, so the buyer
would want the stock to go down.

15. • An interest rate cap is a derivative in which the buyer receives payments
at the end of each period in which the interest rate exceeds the agreed
strike price. An example of a cap would be an agreement to receive a
payment for each month the LIBOR rate exceeds 2.5%.
• Similarly an interest rate floor is a derivative contract in which the buyer
receives payments at the end of each period in which the interest rate is
below the agreed strike price.
• Caps and floors can be used to hedge against interest rate fluctuations. For
example a borrower who is paying the LIBOR rate on a loan can protect
himself against a rise in rates by buying a cap at 2.5%. If the interest rate
exceeds 2.5% in a given period the payment received from the derivative
can be used to help make the interest payment for that period, thus the
interest payments are effectively "capped" at 2.5% from the borrowers
point of view.

16. FOMC 2015
The Federal Open Market Committee continues its march towards
raising interest rates for the first time in nine years.
• Fed Reserve Chair Janet Yellen continues to weigh in on an
assortment of economic data that will justify her decision and the
committee’s during their next meeting in September 2015.
• All indications are the economy is improving, inflation is
maintaining a 2.0% level and that the data dependent Fed will raise
the Fed Funds rate .25% in the coming months
• There is obvious debate about this as the financial markets could be
easily disrupted, shocking the system….
• Many people believe that this historically low interest rate
environment coupled with three rounds of Quantitative Easing was
a mistake during the past seven years. Research has shown that it
benefitted the few, while many Americans realized any benefit from
these policies
• Question for the attendees? What are your thoughts on FOMC
policy during this time? Was QE good for the economy or just
inflate the balance sheet of the federal government?

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