The Optimized Penalty Rate For Draw-in-advance Time Deposits

Summary:The interest rate policy of China has been through many changes since the establishment of PRC, and it began to have a definite goal after the opening of the Third Plenary Session of the fourteenth Central Committee. The marketization of interest rate will inevitably bring a high risk to banks, therefore how to handle the new risk properly calls up the attention of all the bankers. This essay looked back upon the history of China’s policy on interest rate and looked into the marketization of China’s interest rate. The essay aims to determine the optimized penalty rate for draw-in-advance time deposit by pricing the embedded option of time deposits. This essay is based on the study of interest rate hopping model by Lin Hai and Zhen Zhenlong and manages to calculate the option price using the Monte Carlo simulation and finally the optimized penalty rate. Study shows the interest gap between time deposit and call deposit is much higher than the price of the embedded interest option, or the estimated penalty rate. Therefore the essay suggests the commercial banks to lift the call deposit interest rate to provide a more appealing price for the clients.