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(Duration Gap Analysis) For simplicity, assume that a bank currently has the balance sheet in the table below You are considering to issue $50 million

(Duration Gap Analysis)

For simplicity, assume that a bank currently has the balance sheet in the table below

You are considering to issue $50 million long-term bonds to meet its funding requirements among the following two bonds available for possible change in future interest rate.

Bond I: 3-year zero-coupon bonds yielding 6%

Bond II: 5-year 6% annual coupon bonds yielding 6%

4. Calculate Macaulay duration of each bond.

5. Calculate duration gap when each bond is selected respectively.

6. If you believe interest rate to increase by 1 percent to 7%, which one among the above two possible bonds should you choose to increase the bank's net worth and what is the expected change in the bank's net worth?

Value (in millions) Duration (in years) Value (in millions) Duration (in years)
T-Bill 50.00 0.5 Long-term bonds 50.00 3.00
T-Bond 50.00 2.5 Bank Capital 50.00
Question 4. Bond I Bond II
Duration of each bond 3 4.47
Question 5. Bond I Bond II
Duration Gap if each bond is selected 0 -0.73
Question 6. Bond I Bond II
Change in Net worth to a increase by 1%

Only need answer to Question 6: If you believe interest rate to increase by 1 percent to 7%, which one among the above two possible bonds should you choose to increase the bank's net worth and what is the expected change in the bank's net worth?

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