Consider the following two banks and this original scenario.

Bank 1 has assets composed solely of a 10-year, 12 percent coupon, $1 million loan with a 12 percent yield to maturity. It is financed with a 10-year, 10 percent coupon, $1 million CD with a 10 percent yield to maturity (YTM).

Bank 2 has assets composed solely of a 7-year, 12 percent yield to maturity, zero-coupon bond with a current value of $894,006.20 and a maturity value of $1,976,362.88. It is financed with a 10-year, 8.275 percent coupon, $1,000,000 face value CD with a yield to maturity of 10 percent. All securities except the zero-coupon bond pay interest annually.

1. If interest rates rise by 1 percent (100 basis points), compute the new market values (prices) of each fixed-income security, using the new YTMs, i.e, compute the actual price volatility (APV).

Bank 1

Old MV_A: _______ Old MV_L: ________ Old Net Worth: ___________

New MV_A: _______ New MV_L: ________ New Net Worth ___________

Bank 2

Old MV_A: _______ Old MV_L: ________ Old Net Worth: ___________

New MV_A: _______ New MV_L: ________ New Net Worth ___________

2. Return to the original scenario. Compute the duration (D) of each banks assets and liabilities.

Bank 1

D_A: _______ D_L: ________

Bank 2

D_A: _______ D_L: ________

3. Using the duration-based Implied Price Volatility (IPV) formula, compute the price changes for each banks assets and liabilities, in response to a 1 percent change in interest rates, from the original scenario.

Bank 1

New MV_A: _______ New MV_L: ________ New Net Worth ___________

Bank 2

New MV_A: _______ New MV_L: ________ New Net Worth ___________

4. Repeat step (i) using a 10 percent increase in interest rates, from the original scenario.

Bank 1

Old MV_A: _______ Old MV_L: ________ Old Net Worth: ___________

New MV_A: _______ New MV_L: ________ New Net Worth ___________

Bank 2

Old MV_A: _______ Old MV_L: ________ Old Net Worth: ___________

New MV_A: _______ New MV_L: ________ New Net Worth ___________

5. Repeat step (iii) for a 10 percent rise in interest rates, from the original scenario.

Bank 1

New MV_A: _______ New MV_L: ________ New Net Worth ___________

Bank 2

New MV_A: _______ New MV_L: ________ New Net Worth ___________

What do you conclude about (a) how well IPV works as an approximation for actual price volatility State with two bullet points and illustrate your statement with two graphs in one correctly labeled and titled figure. (b) the two banks accounts and their interest rate risk exposure? Why is the impact on their net worth different? State with two bullet points.