A financial institution has a balance sheet with the following assets (at book values): $40 million of 6-month Treasury bills, and $80 million of fixed-rate 10-year loans.

The liabilities (at book values) are: $40million of sight deposits, $50million of 2-year deposits, a senior unsecured bond repayable in 10 years of $20m and the remainder in equity.

The current market (central bank rediscount) interest rate is 0.5%. T-bills pay the market rate, loans were issued at a premium of 3% on the market rate.

Sight deposits were collected at a discount of 0.5% on the market rate, the 2-year time deposits are financed at a premium of 0.25% on the market rate and the 10 year bond is issued at a premium of 1.5% to the Market Rate.

Assume that all items are new to the balance sheet on day 1 and that any maturing items roll over at their original balances.

Carry out an interest rate risk analysis using three re-pricing buckets: 0-6 months, 6 months 3 years, and more than 3 years and then:

1. Compute the Financial Institution Annual net interest income.

(4 marks)

2. Compute the marginal and cumulative re-pricing gaps for all three buckets.

(6 marks)

3. Compute the effect on annual net interest income of a 1% increase in market interest rates for a 6-month horizon (note that the increase in interest rates is a parallel shift of the yield curve).