Consider the following bank balance 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) 325 1 0 2Year Car Loans 275 2 0 30Year Mortgages 400 7 0 Total Assets (A) 1,000 Liabilities and Equity Super Now Checking Accounts (rates set monthly) 350 1 0 6Month Certificates of Deposit 250 5 3Year Certificates of Deposit 300 3 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 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 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 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 e In the above balance sheet, which asset is most responsible for the duration mismatch Describe how using a futures contract of a security with a duration similar to that of the asset causing the duration mismatch might be done and by how much to get full interest rate immunization f Given a banks portfolio as described above, suppose the banks regulators required that the bank increase its equity by $10 million What is the effect on the interest sensitivity of the bank if it reduced its liabilities by $10 billion in Super Now Checking Accounts to $340 million if rates are expected to rise by 200 basis points

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

Consider the following bank balance 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) 325 1.0

2Year Car Loans 275 2.0

30Year Mortgages 400 7.0

Total Assets (A) 1,000 ?

Liabilities and Equity

Super Now Checking Accounts (rates set monthly) 350 1.0

6Month Certificates of Deposit 250 .5

3Year Certificates of Deposit 300 3.0

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 ?

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?
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?
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.

e. In the above balance sheet, which asset is most responsible for the duration mismatch? Describe how using a futures contract of a security with a duration similar to that of the asset causing the duration mismatch might be done and by how much to get full interest rate immunization?

f. Given a banks portfolio as described above, suppose the banks regulators required that the bank increase its equity by $10 million. What is the effect on the interest sensitivity of the bank if it reduced its liabilities by $10 billion in Super Now Checking Accounts to $340 million if rates are expected to rise by 200 basis points?