Journal of Risk

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First Derivatives National Bank: a case problem in the management of interest rate risk

Richard J. Rendleman, Jr.

ABSTRACT

First Derivatives National Bank is a case problem that illustrates the use of Heath-Jarrow-Morton type arbitrage-free stochastic term structure models in the measurement and management of interest rate risks of a hypothetical commercial bank. Unlike the more traditional duration-based approach to interest rate risk management, the stochastic term structure approach is able to capture the option-like features associated with securities and derivative products held and issued by the bank. With this framework of analysis, the case illustrates how a commercial bank that holds and issues complex interest-sensitive assets and liabilities can set the interest rate risk exposure of its equity position to a predetermined target.

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