7.2 B-E

Bank Balance Sheet

Item Amount Duration Interest Rate

Cash-type Securities $50m 1.2 year 2.25%

Commercial Loans $100m 2.4 years 4.50%

Mortgages $350m 8.0 years 6.50%

Core Deposits $270m 1.0 year 2.00%

Notes Payable $180m 2.0 years 4.50%

2. On-Balance Sheet Immunization Analysis (Use balance sheet information above, 6 points)

Immunization formulas: 1) Setting D_A x A = D_L x L will immunize the bank against interest rate risk.

(D=Duration,L=Liabilities,A=Assets)

Setting the Leverage-Adjusted Duration Gap equal to 0 will also immunize the bank against interest rate risk

(0 = D_A k D_L ).

Assume the bank wants to leave its assets unchanged, and change the composition of its liabilities, but keep the current dollar amount of liabilities the same.

B. What D_L would immunize the bank against interest rate risk? Use either immunization formula.

C. Assume the bank wants to keep its core deposits unchanged, but can issue new zero coupon bonds of any maturity to replace all of the current notes payable, and thereby achieve the desired D_L. Calculate the required maturity of the zero-coupon bonds to immunize the bank against interest rate risk.

D. If the strategy in part b immunizes the bank from interest rate risk, and interest rates do rise from an average rate of 6.0% to 7.0%, calculate the new value of the banks assets (A), the banks liabilities (L) and the net worth (E). Use the formula: %A or %L = -D x [ R / (1 + R) ]

E. Explain the main implications of this exercise in a full essay of a full paragraph or more, and refer specifically to your numerical results above.