Consumer Bank has $20 million in cash and a $180 million loan portfolio. The assets are funded with demand deposits of $18 million, a $162 million CD, and $20 million in equity. The loan portfolio has a maturity of two years, earns interest at an annual rate of 7 percent, and is amortized monthly. The bank pays 7 percent annual interest on the CD, but the principal will not be paid until the CD matures at the end of two years.

a. What is the maturity gap for Consumer Bank?

b. Is Consumer Bank immunized, or protected, against changes in interest rates? Why or why not?

c. Does Consumer Bank face interest rate risk? That is, if market interest rates increase or decrease 1 percent, what happens to the value of the equity?

d. How can a decrease in interest rates create interest rate risk?

LO.1