Consider the following bank balance e sheet (fixed rates and pure discount securities unless indicated otherwise).Interest rates on liabilities are 4 percent and on assets are 6 percent.

Duration

$billions(years)

Assets

PrimeRate Loans (rates set monthly)3251.0

2Year Car Loans2752.0

30Year Mortgages4007.0

Total Assets (A)1,000?

Liabilities and Equity

Super Now Checking Accounts (rates set monthly)3501.0

6Month Certificates of Deposit250.5

3Year Certificates of Deposit3003.0

Total Liabilities (L)900?

Equity (E)100

Total Liabilities (L) and Equity (E)1,000

a.What is the duration of assets, D_A, and liabilities, D_L ?

b.Given the duration imbalance of assets and liabilities, what is the loss in market value of (1) assets, (2) liabilities and (3) equity as a result of an interest rate rise by 200 bp for assets and liabilities?

c. Compute the repricing gap for the bank using those assets and liabilities repricing, maturing in 2 years or less or with a duration of 2 years or less. From this information, will the bank benefit or be hurt by a 200 basis point rise in interest rates on assets and liabilities?

d.Find the duration of assets, assuming the duration of liabilities remains the same, that will fully immunize the market value of net worth of the bank from interest rate changes?Define net worth immunization and state the advantages and disadvantages of using it and asset/liability duration as a means of mitigating interest rate risk.