Question
Insurance Company issued a $90 million, one-year note at 8 percent annual interest (paying one coupon at the end of the year) with an 8
Insurance Company issued a $90 million, one-year note at 8 percent annual interest (paying one coupon at the end of the year) with an 8 percent yield. The proceeds, plus $10 million in equity, were used to fund a $100 million, two-year commercial loan with a 10 percent coupon rate and a 10 percent yield. Immediately after these transactions were simultaneously closed, all market interest rates increased 1.5% (150 basis points).
a. What was the duration of the commercial loan when it was first issued? b. What is the duration of the liability, which is a note, at the time of issuance? c. What is the leverage adjusted duration gap of Carthage Insurance Company after the issuance of the note? d. What is the predicted change in equity value that forecasted by the duration gap when the interest rate increases by 1.5%? e. What is the market value of the loan investment and the liability after the change in interest rate? What is actual impact on the market value of equity when the interest rate increased by 1.5%? f. Using the duration rule, what is the expected change in the value of the loan if the interest rate is expected to increase to 11.5% from the initial 10%?
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