Matched Book What it Means How it Works

Matched Book: What it Means, How it Works

What Is a Matched Book?

A matched book is an approach that banks and other institutions may take to ensure that their assets and liabilities have equally distributed maturities. It is also known as "asset/liability management" or "cash matching."

Adopting the matched book method provides functional benefits, as it allows financial entities to supervise liquidity and manage interest rate risk. However, not all institutions utilize this approach.

Understanding Matched Books

A matched book is a risk management technique for banks and financial institutions, ensuring equal value and maturity between liabilities and assets. By adopting this approach, a bank seeks to balance lending and liquidity, enabling better risk oversight.

Key Takeaways

– A matched book ensures equal distribution of the maturities of assets and liabilities in financial institutions.

– It is also referred to as "asset/liability management" or "cash matching."

– The methodology reduces spread risk, which is the potential change in value between expected and actual market price of credit risk.

– Traders may use a matched book method to take advantage of short-term interest rate changes associated with underlying stock supply and demand.

In the matched book method, efforts are made to maintain parity between assets and liabilities, including the amortization of assets. The method also matches interest rates for assets and liabilities.

This involves matching fixed loans to fixed-rate assets and floating-rate loans to floating-rate assets. For floating-rate instruments, interest rate resets need to coincide with specified intervals.

Ways a Matched Book Is Applied

The matched book methodology helps reduce spread risk, which refers to potential value changes in credit risk. This risk is particularly associated with riskier bonds.

In repo transactions, a different approach can be taken for a matched book. In this instance, a bank may use reverse repurchase agreements and repurchase agreements to maintain a matched book, even without a balanced position. The bank may borrow at a lower rate and lend at a higher rate to earn a spread and generate profits.

There are various examples of matched book application. Banks may trade repurchase agreements to cover short and long bond positions. Traders may also maintain a matched book to capitalize on short-term interest rate changes related to underlying stock supply and demand.

Unlike banks that focus on risk mitigation, traders adopt the matched book method to take advantageous positions across different bonds and stocks.