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Handbook of Asset and Liability Management: From models to optimal return strategies by Alexandre Adam

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2

What is Asset and Liability Management Today?

L'histoire est un perpétuel recommencement. (Thucydide)

The Asset and Liability Management Department is a creation that evolved out of banking and insurance history. The financial crisis of the 80s and 90s (from S&Ls to LTCM) proved the importance of Risk Management in decision taking.

During this period, frightened executive managers created or empowered Risk Management Departments. ALM teams were formed at the same time, bringing organization and strategy into question.

2.1 ALM AND THE BANKING INDUSTRY

2.1.1 Banking Book and Trading Book

We often divide the bank balance sheet in two parts: the Banking Book and the Trading Book.

The Trading Book is made up of all the operations accounted for in marked-to-market coming from the “trading room” businesses: Fixed Income Department, Equity Derivatives Department, Credit Derivatives, Commodity Trading, Forex, etc. It includes derivatives sold to customers, hedging strategy developed in front of these derivatives, Bonds accounted as trading, etc.

The Team responsible for P&L (Profit and Loss) manages the Trading Book.

The usual approach is a “trade approach”. For example, the Fixed Income Department through its sales team records a derivative contract with a client. A Fixed Income Trader books the derivative contract presenting a positive valuation. The trader hedges the derivative using futures and may hold a small mismatch position.

The risk taken is minimal and sometimes provides ...

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