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CFO Curency May 2015

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CFO CURRENCY: BY EMILY MORÉ HOLLIS

What Is the Big Deal About Up 300 Basis Points in NEV Tests?

What impact will moving rates up 300 basis points have on your credit
union? One financial expert crunches the numbers with an ARM example
that demonstrates what such a scenario could spell when it comes to
cumulative price changes and volatility.

Iwas recently conducting an ALM training session with a credit union, when a bright board member asked, “What is the purpose of moving rates up 300 basis points (bps)? That will never happen instantaneously.” The answer is that, even though we are unlikely to see an immediate rate increase of three percent, it’s important to measure price volatility mismatches and the negative convexity inherent in the balance sheet.

But how do you explain this to a board member whose emphasis is not in finance?

The best way I can describe its purpose is to correlate a net economic value (NEV) test with a beta on a stock trade. A “beta” is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison with the market as a whole. It isn’t a perfect example by any means, but the intent is somewhat similar. That is because it is a measurement to compare and produce outliers for institutions that have greater volatility than the norm. Hence, it’s used to elicit red flags where failures could occur due to withdrawals, forced liquidation of assets, depletion of capital or bankruptcy.

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