In schweser page 175 LADG = D asset - (L/A) D liabilities If increase in interest rate if LADG < 0 , market value of equity will decrease if LADG > 0 , market value of equity increase Guys i can’t understand any thing related to this concept !!!. Any one please help me and explain it in details.
Okay from the top of my head as I don’t have a book here and quite frankly I haven’t gotten to SS 5 yet… anyway… Banks assets are interest rate sensitive. That means that all gains/losses hit equity right away. Think interest rate sensitivity and you’ll see that it makes sense.
A = E+L Da * (E+L) - Dl * L = Dollar change in equity A * (Da - L/A * Dl) = Dollar change in equity so if (Da - L/A * Dl) is positive then as interest drops your equity increase, else otherwise
I feel stupid 
. I still can’t understand what LADG mean and why when LADG is positive ( when interest rate increase ) the equity part will increase !!! . Any one in tedails ?
Okay I’ll give it a shot. The assets of banks are predominantely in interest rate sensitive assets. The LADG is the duration of these assets EXCLUDING the leveraged duration of its liabilities. Therefore, interest rate changes directly change the bank’s equity. With a LADG below zero, equity negatively correlated to interest rate. So if interest rates rise, its equity drops. Vice versa if LADG is above zero. Did it help?
does this mean that if LADG>0, equity exhibits positive convexity as a function of interest rates, much like a bond? just trying to find similarities. thanks.
It’s about duration, not convexity.
yeah, sorry, duration. it acts like a bond duration if LADG>0?
and related to this subject, could somebody please explain why… If bank managers forecast increasing interest rates, they can decrease the duration of the assets by decreasing the duration of the securities portfolio thanks
Firstly, I believe you have copied this info from Schweser incorrectly. If increase in interest rate if LADG < 0 , market value of equity will increase (not decrease) if LADG > 0 , market value of equity decrease (not increase) This is how I see it. If LADG<0, then the duration of assets is less than the adjusted duration of the liabilities. Based on this, if interest rates increase, then the MV of assets (with a lower duration) will drop less than the MV of the adjusted liabilities (with a higher duration) resulting in a higher equity. Similarly, if LADG>0, then duration of assets exceeds adjusted duration of the liabilities. If interest rates increase, the MV of assets (with a higher duration) will fall more than the MV of the liabilities (with a lower duration) resulting in a lower equity. Hope this helps.
After deep thinking i wish i’m right First of all consider asset is a loan so you earn interest on loan and consider liability is deposit and you pay interest on deposit. Now let’s present the formula again LADG = D asset - (L/A) D liabilities If LADG is negative which mean the duration of Asset (loans) is lower than the duration of liability (deposit). That’s mean you have short term investment (loans) and in the same time have long term obligation (deposits). Now if we expect a decrease in interest rate We already have short term investment (loans that give us a high interest rate), so when interest rate will decline we will face reinvestment risk (reinvest bank money at lower discount rate. In the same time we have long term obligation which mean that we have to pay the obligated higher discount rate on our deposit and can’t benefit from new lower discount rate. You notice now that there is mismatch between income from loan (lower) and expense (interest paid on deposit) (higher) so the bank net equity will decline. I’m right guys ???
Did you even read what i wrote?
Yes comp but i couldn’t undersatnd your explaination sorry :).