Portfolio Monitoring, Analysis, and Reporting

Paterson's proprietary Interest Rate Risk model analyzes existing assets and liabilities for their sensitivity to changes in interest rates, the yield curve, and credit conditions.

Paterson separates a portfolio into it's derivative parts and analyzes each component for changes due to interest rate, credit, and currency risks. Then, the parts are re-aggregated into a series of summary measures based on potential market changes.

For example, if a business holds a fixed rate mortgage on a US property, the asset itself is a combination of separate risks, including the bond portion, the prepayment option, and the related credit risk. The portfolio is long a bond and short a call, while also long credit quality. Each of these risks are treated separately at first, then aggregated with other risks.

From this report, management can adjust the pricing of new assets and liabilities to grow - or shrink - the portfolio into higher return on equity based on market-based opportunities.

Market Monitoring and Analysis

Paterson's market monitoring service observes, analyzes, explains and predicts changes in interest rates due to inflation, Fed action, market changes, and credit risks, allowing A/L managers time to adjust tactics to deal with forecasted changes as they evolve.

From changes in A/L pricing, to market adjustments of the portfolio and hedging opportunities, changes in interest rates present opportunities for better earnings with manageable interest rate risk.

Continuous observation and analysis allows Paterson to present the current situation in a historical perspective, analyze opportunities and risks, and suggest changes in A/L pricing.

Asset and Liability Pricing

Paterson analyzes changes in assets and liabilities to determine the effectiveness of new business to improve the profitability of the organization and lower the risk the portfolio faces in different interest rate environments.

The A/L team must develop a plan to price assets and liabilities so that profitability is ensured and interest rate risk is held within the bounds set by prudent portfolio management.

Competition from others engaged in similar activities constrains A/L pricing opportunities and directs the company's energies into areas where the portfolio can add new business with sufficient spread over liability costs to ensure profitability.

Portfolio Adjustments in Cash Markets

Once the opportunities for portfolio management through pricing are established, A/L managers can then take advantage of market-based solutions to add assets and liabilities in the appropriate places of the portfolio to improve earnings.

From adding assets with the appropriate yield, maturity and risk, to placing liabilities to fund asset growth, opportunities in the cash markets can fill holes in the portfolio until the business can generate its own assets and liabilities.

Trading and Hedging Monitoring and Training

Trading in the cash markets is the policy of adding assets and liabilities to the portfolio to improve earnings and reduce risk and is managed by the A/L department. Trading for profit is not the business of the A/L department.

As interest rates fluctuate, portfolio managers will find opportunities in the cash markets to improve asset yield, lower liability costs, and better match the interest rate risks of the portfolio. Traders execute these programs in the markets.

Hedging is the last resort for A/L managers given the cost and risks involved, yet at times, only hedging allows the profitable growth in the portfolio, allowing new business to be booked and then hedged for short periods till the appropriate term and credit match can be made.

When A/L opportunities arise, due to changing market conditions, and there are no effective pricing options available, the portfolio can still add either assets and liabilities and fill any short term risks with an equal and opposite position in the cash, futures, options, and swaps markets.

Paterson also monitors trading activity and trains traders for A/L management.

Audit Risk Management

In the trading department, there are opportunities for error and fraud that can destroy and institution. Paterson analyzes trading policies, procedures, and activities to prevent losses from mistaken or unauthorized activity.

Working with internal and outside auditors, Paterson advises on the ability of the existing risk management program to effectively control trading.

Money Market Arbitrage

As the yield curve changes, credit risk expands, and as spreads between US Treasuries and other instruments widen, financial institutions will find profitable opportunities in money market arbitrage.

Risks are low in money market arbitrage because yields can be matched against both changes in rates and the yield curve.

 

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