7. (a) Compare and contrast income gap and duration gap analysis as techniques for management of interest rate risk by banks. (12 marks) (b) Consider the following balance sheet of Fairview Bank: Assets (E) Duration Liabilities (E) Duration Variable-rate 1900 8.3 Money market 3700 1.1 mortgages deposits Fixed-rate 1500 7.1 Savings 4200 3.2 mortgages deposits Commercial 6500 5.0 Variable-rate 2200 1.5 loans CDs Physical capital 2900 Equity 2700 Total 12800 Total 12800 What will be the change in net interest income at the year-end if interest rates decrease by 0.5 per cent, from 4 to 3.5 per cent? Explain using basic gap analysis. (Use the following assumptions for runoff cash flows: fixed-rate mortgages repaid during the year: 15 per cent; proportion of savings deposits and variable-rate CDs that are rate-sensitive: 15 per cent). (7 marks) (c) Calculate the duration gap for Fairview Bank? Explain why a bank will normally have a duration gap greater than zero. (6 marks)