Assume Bank one has the following items in its balance sheet: Rate sensitive Asset 20. Rate sensitive Liabilities 50m. Fixed rate assets 80m. Fixed rate liablities 40m. Capital 10m. Assume the duration of the assets is 2 years and that of its liablities is 3 years. Assume the interest rates are initially 5%.

a. List the above items in a T account

b. What is the income gap for the bank?

c. What will happen to the income of the bank if interest rates increased by 1%? Explain using gap analysis

d. The bank manager overheard that Bank of Canada is planning to cut the interest rates. He decided to sell 10m of fixed rates assets and buy 10m of rate sensitive liabilities. Would you agree with the manager’s decision? Why or why not?

e. If interest rates decreased from 5% to 4% calculate the change in the market value of the net worth as a percentage of total assets. Explain using gap analsysis. f. The manager of the bank expected that the interest rates will fall sharply. To mitigate interest rates risk he shortened the duration of the liabilities side. Would you agree with him? Why or why not?