Banks

Asset: Long-term Loans

Liabilities: Short-term Deposits

Asset-liability duration mismatch

Bank Security (from those cannot be loaned out):

Hold to maturity (only recognize dividends)

Available for Sale – intended to sell prior to maturity (recognize non-realized G/L)

Trading Securities – buy for short term due to mispriced

Leverage Adjusted Duration Gap (LADG)

= D_asset – (L/A) * D_liabilities

Note that D_asset+D_liabilities is nothing!

Return: Earn Interest Spread

Risk: Must meet liabilities

Liquidity: demand for loans and deposit withdrawal and regulations

Unique Circumstances

Time Horizon – average maturities of deposits

Legal and regulatory

Firms sensitive to interest rate should pursue asset-liabilities management

Mutual Funds – fit any styles

Commodity pools – invest in futures

Hedge Funds – to identify mispricing