5. Suppose that XYZ Banks balance sheet is:

Asset (million cedis) Loans 200

Total 200

Liabilities (million cedis) Deposit 160

Equity 40

Total 200

Assume that the duration of the asset is 5 years and that of the liability is 3 years. The bank expects interest rate to rise by 1% from the current level of 10%.

a) Calculate the potential loss on the banks net worth.

b) Prepare the banks balance sheet after the rate change.

[8 marks]

Examiners: Prof. Joshua Y. Abor; Dr. E. Sarpong-Kumankoma Page 2 of 3

6. A bank holds a 10-year $2 million face value bond with a duration of 8 years. The current price = $950,000. Interest rates are expected to increase from 9% to 11% over next 3 months. Demonstrate how the bank can use a forward contract to hedge the interest rate risk. [4 marks]