March 4 - This volatile rate environment requires CUs to carefully evaluate balance sheet strategies. For example, securities with embedded calls receive higher rates because the CU has sold an option - the issuer can redeem the security on call dates if rates fall. If market rates rise a CU will own the security beyond its call date, now at below market yields. Compelled to raise share rates to compete with the higher market rates, CU income will decline. CUs using models to measure this risk should be sure the effect of the call is reflected in the risk measurement.
Risk models showing the price impact of a rate shock are more likely to capture the risk.
Income models, particularly those with one to two year time horizons, can miss the impact. Rate shock tests estimate potential exposure. Using income simulation is an important first step. However, income simulations usually go out only a few years and can miss longer term effects. Measures of price change capture the full impact.