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Assume the following about UMB: Current market rate = 4.36%. Use a 30-day month and a 360-day year when computing yields, etc. See notes for

Assume the following about UMB:

Current market rate = 4.36%.

Use a 30-day month and a 360-day year when computing yields, etc.

See notes for other information.

Carry out computations to at least 6 decimal places. Round final answers to 3 decimal places.

Use whole numbers on balance sheet account amounts.

You are the asset-liability manager at UMB. The Board of Directors has asked you to provided risk management solutions in each of the following two scenarios. Explain in detail your answers to the accompanying set of questions. Consider each of the scenarios independently of one another.

The following Exhibits will prove helpful:

Exhibit A: Selected Interest Rate Futures quotes for Eurodollars

Exhibit B: Selected Interest Rate Futures quotes for T-Bonds

UMB bank has the following balance sheet information as of September 30, 2016:

Amount

Wtd. Avg. Dur

Assets

$950,000,000

4 years

Liabilities

$800,000,000

6 years

Equity Capital

$150,000,000

Total Liabilities & Capital

$950,000,000

The bank believes interest rates will decrease 100 bp over the three months. The bank is concerned about the impact this decrease in rates will have on its capital (i.e. equity). You advise the bank to hedge this interest rate risk exposure by immunizing its DGAP using T-Bond futures contracts expiring in March 2017.

1. Explain in detail how a hedge using T-Bond futures contracts will work.

Be sure to answer the following questions:

a. What is the DGAP of capital (round to 4 decimal places)?

b. Should the bank go long or short? Why?

c. How many T-Bond futures contract should the bank trade to hedge this risk? Assume br = 1 and the duration of the T-Bond futures contracts = 5.2 years. Refer to Exhibit B for prices.

d. What is the total dollar value of the T-Bond futures contracts?

2. Assume UMB takes the advice you offer in number 1 above. On December 31, 2016, interest rates have decreased 100 basis points. On December 31, the bank unwinds its futures position. (All answers should be in dollars).

a. What is the banks gain or loss in the futures market?

b. What is the banks gain or loss in the cash market (i.e., the change in capital)?

c. What is the banks net gain or loss on the hedge?

d. What is the banks new capital balance inclusive of the effects of the hedging derivatives?

e. For the bank to experience no change or a positive change in net worth due to a change in interest rates, what must the minimum price of the March17 T-bond futures contract have been at December 31, 2016? Give answer as a T-bond quote.

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