Estimated reading time: 4 minutes

## Introduction

We present the formulas for the Liquidity and Treasury Risk Measurement segment.

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## Bid-Offer Spread

One measure of the market liquidity of an asset is its bid–offer spread.

This can be measured either as a dollar amount or as a proportion of the asset price

## The dollar bid–offer spread

p = Offer price – Bid price

## The proportional bid–offer spread

s = ( Offer price – Bid price ) / Mid-market price

## Cost of liquidation (normal market)

Σ_{i} ( s_{i} * *α*_{i }/ 2 )

Where:

s_{i} is an estimate of the proportional bid–offer spread in normal market conditions for the i^{th} financial instrument held by a financial institution

*α*_{i }is the dollar value of the position in the instrument

## Liquidity-Adjusted VaR (normal market)

VaR + Σ_{i} ( s_{i} * *α*_{i }/ 2 )

## Liquidity-Adjusted VaR (stressed market)

VaR + Σ_{i} [ [ ( m_{i} + lσ_{i} ) *α*_{i } ] / 2 ]

## Cost of liquidation (stressed market)

Σ_{i} [ [ ( m_{i} + lσ_{i} ) *α*_{i } ] / 2 ]

Define m_{i} and σ_{i} as the mean and standard deviation of the proportional bid–offer spread for the i^{th} financial instrument held.

The parameter l gives the required confidence level for the spread.

For example, if we are interested in considering “worst case” spreads that are exceeded only 1% of the time, and if it is assumed that spreads are normally distributed, then l = 2.326

## The liquidity coverage ratio (LCR) requirement

( High-quality liquid assets / Net cash outflows in a 30-day period ) ≥ 100%

## The net stable funding ratio (NSFR) requirement

( Amount of stable funding / Required amount of stable funding ) ≥ 100%

## The Leverage Ratio

1 + ( D/E )

Where:

D = Debt

E = Equity

## After-tax gross yield

Before-tax gross yield * ( 1 – Firm’s marginal income tax rate )

## The Tax Equivalent Yield ( TEY )

TEY = After-tax return on a tax-exempt investment / (1 – Investing firm’s marginal tax rate)

## Net after-tax return on municipals (in % )

[ Nominal return on municipals after taxes (in %) – Interest expense incurred in acquiring the municipals (in %) ] + Tax advantage of a qualified bond

## Percentage change in Investment Price

– Duration * [ (Change in interest rate) / ( 1 + (1/m)*(Initial Rate) ]

Where m is the number of times during the year that the security pays interest

## Financial Firm’s Net Liquidity Position, L_{t}

= Supplies of Liquidity Flowing into the Firm – Demands of the Firm for Liquidity

Where:

Supplies of Liquidity Flowing into the Firm

= Incoming Deposits + Revenues from Services + Customer Loan Repayments + Sale of Assets + Borrowings

Demands of the Firm for Liquidity

= Deposit Withdrawals – Loan Requests – Borrowing Repayments – Operating Expenses – Dividend Payments to Stockholders

## Expected Liquidity Requirement

Probability of Outcome A * (Estimated liquidity surplus of deficit in Outcome A)

+

Probability of Outcome B * (Estimated liquidity surplus of deficit in Outcome B)

+

Probability of Outcome C * (Estimated liquidity surplus of deficit in Outcome C)

+

+…

## Cash position indicator

Cash and deposits due from depository institutions / total assets

## Liquid securities indicator

U.S. government securities / total assets

## Net federal funds and repurchase agreements position

(Federal funds sold and reverse repurchase agreements – Federal funds purchased and repurchase agreements) / total assets

## Capacity ratio

Net loans and leases / total assets

## Pledged securities ratio

Pledged securities / total security holdings

## Hot money ratio

Money market (short-term) assets / volatile liabilities

= (Cash and due from deposits held at other depository institutions + holdings of short-term securities + Federal funds loans + reverse repurchase agreements) / (large CDs + Eurocurrency deposits + Federal funds borrowings + repurchase agreements)

## Deposit brokerage index

Brokered deposits / total deposits

## Core deposit ratio

Core deposits / total assets

## Deposit composition ratio

Demand deposits / time deposits

## Loan commitments ratio

Unused loan commitments / total assets

## Marginal cost rate

Change in total cost / Additional funds raised

## Annual Percentage Yield (APY)

APY earned = 100 [ ( 1 + Interest earned/Average account balance )^{(365/Days in period)} – 1 ]

## Available Funds Gap (AFG)

AFG = [ Current and projected loans and investments the lending institution desires to make ] – [ Current and expected deposit inflows and other available funds ]

## Effective cost rate on deposit and non-deposit sources of funds

= [ Current interest cost on amounts borrowed + Non-interest costs incurred to access these funds ] / Net investable funds raised from this source

Where:

Current interest cost on amounts borrowed = Prevailing interest rate in the money market * Amounts of funds borrowed

Non-interest costs incurred to access these funds = Estimated cost rate representing staff time, facilities, transaction costs * Amounts of funds borrowed

Net investable funds raised = Total amount borrowed – legal reserve requirements (if any), deposit insurance assessments (if any), and funds placed in non-earning assets

## Pooled deposit and non-deposit funds expense

All expected operating expenses / All new funds expected

## Hurdle rate of return over all earning assets

All expected operating costs / Dollars available to place in earning assets

## Weighted Average Life ( WAL )

= ∑ ( p_{i} / P ) t_{i}

Where:

P_{i} = principal amount in distribution i,

P = amount of loan

t_{i} = time (in years) of payment i

## Funds Transfer Price ( FTP )

= Base Rate + Term Liquidity Premium + Liquidity Premium

Where:

Base Rate = rate depicted from the swap curve corresponding to the asset’s contractual / behavioral maturity or repricing term, whichever is less

Term Liquidity Premium = spread between the swap curve and the bank’s marginal cost of funds curve based on the contractual/ behavioral maturity of the asset

Liquidity Premium = cost of carrying liquidity cushion averaged over total assets of the bank

## Bank Discount Rate

= [ ( 100 – Purchase Price on Security or Loan ) / 100 ] * ( 360 / # days to Maturity )

## YTM Equivalent Yield

= [ ( 100 – Purchase Price ) / Purchase Price ] * ( 365 / Days to Maturity )

## Nominal (Published) Market Interest Rate on a Risky Security or Loan

= Risk Free Rate + Risk Premiums to Compensate Lenders

## Net Interest Margin ( NIM ) = Net Interest Income / Total Earning Assets

= ( Interest from Loans and Investments – Interest Expense on deposits or borrowed funds ) / ( Total Earning Assets )

## Interest Sensitive Gap

= Interest Sensitive Assets – Interest Sensitive Liabilities

## Relative IS GAP

= IS GAP / Size of Financial Institution

## Net Interest Income

= Total Interest Income – Total Interest Cost

## Change in Net Interest Income

= Overall change in Interest Rate (in percentage points) * Size of the Cumulative Gap (in dollars)

## Duration Gap

= Dollar Weighted Duration of Asset Portfolio – Dollar Weighted Duration of Liability Portfolio

## Leverage Adjusted Duration Gap

= Duration Gap * (Total Liabilities / Total Assets)

= (Dollar Weighted Duration of Asset Portfolio – Dollar Weighted Duration of Liability Portfolio) * (Total Liabilities / Total Assets)

## Dollar Weighted Asset Portfolio Duration

= ∑( Duration of Each Asset in Portfolio ) * Market Value of Each Asset in Portfolio / ( Total Market Value of all Assets )

## Current Leverage-Adjusted Position

= Average Asset Duration – [ Average Liability Duration * ( Total Liabilities / Total Assets ) ]

## Conclusion

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