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Consider a bank that holds government bonds and consumer loans as assets. In particular, the bank holds a zero-coupon government bond with maturity of 10
Consider a bank that holds government bonds and consumer loans as assets. In particular, the bank holds a zero-coupon government bond with maturity of 10 years that promises to pay 15m in year 10. The bank's loan portfolio matures in 2 years: it pays 2m in the first year and 12m at the end of the 2nd year. The bank has 20m (present value) worth of liabilities with an average duration of 4 years. The risk-free interest rate is 5%. a) What is the (present) value of bank's assets? What is the value of bank's equity? b) What is the average duration of the bank's assets? c) What change in the interest rate would make the bank insolvent? d) How can the bank eliminate interest rate risk? Explain the possibilities in this case. Keeping everything else the same, what should the duration of the bank's liabilities be to make the bank's value insensitive to changes in the interest rate? Consider a bank that holds government bonds and consumer loans as assets. In particular, the bank holds a zero-coupon government bond with maturity of 10 years that promises to pay 15m in year 10. The bank's loan portfolio matures in 2 years: it pays 2m in the first year and 12m at the end of the 2nd year. The bank has 20m (present value) worth of liabilities with an average duration of 4 years. The risk-free interest rate is 5%. a) What is the (present) value of bank's assets? What is the value of bank's equity? b) What is the average duration of the bank's assets? c) What change in the interest rate would make the bank insolvent? d) How can the bank eliminate interest rate risk? Explain the possibilities in this case. Keeping everything else the same, what should the duration of the bank's liabilities be to make the bank's value insensitive to changes in the interest rate
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