Part One: Briefing to the Bank CEO

The Accounts Department of a major bank forecasts an increase in interest rates (R) of xxx bps and the Senior Management of the bank is concerned about the impact of this possible interest rate increase on the performances of the bank and its balance sheet. Your group has been appointed as a risk management team and are requested to provide a risk analysis of the bank.

Using the data submitted by the Accounts Department below, evaluate the state of the bank and submit your finding in a brief report to the CEO. The CEO is also interested in a recommendation regarding a future strategy.

1. In this case, using your understanding about the interest rate risk as discussed in this unit, you are required to measure the interest rate risk using the duration model. To complete this task construct the portfolio duration of assets and liabilities, estimate the duration gap, and then apply duration gap analysis to estimate the change in net worth arising from the interest change;

1. Following the analysis in part II above, formulate a strategy to cover any decline in net worth using futures.

Assets	($million)	Market yields %	Duration
Cash Interbank lending 3-month T-notes 2-year T-bonds 5-year T-bonds 10-year T-bonds Consumer loans Business loans Fixed-rate mortgages Variable-rate mortgages Premises & equipment	250 850 600 500 750 1,000 800 450 1,300 700 250	- 5.00 2.50 3.25 5.00 5.75 6.00 5.80 5.85 3.85 -	- 0.02 0.25 2.00 * * 2.50 6.58 19.50 0.50 -
Total assets	7,450
Liability & Equity
Demand deposits Savings accounts 3-month CDs 6-month CDs 1-year CDs 5-year CDs Interbank borrowings Commercial paper Subordinated debt: fixed rate	400 540 425 400 750 1,950 985 600 500	- 1.50 2.00 2.50 3.25 4.00 4.00 5.05 7.25	- 0.50 0.25 0.50 * * 0.02 0.45 6.65
Total liabilities	6,550
Equity	900
Total liabilities and equity	7,450

1. The coupon rate paid on 5-year T-bonds is 4.50% (per annum). The coupon payment is received semi-annually.
2. The coupon rate paid on 10-year T-bonds is 5.50% (per annum) and the coupon payment is received annually.
3. Variable rate mortgages are repriced every six months.
4. Fixed rate mortgages are for a five-year period.
5. 1-year CDs have been issued with a coupon rate of 3.00% (per annum, semi-annual payments)
6. 5 year CDs have been issued with a coupon rate of 3.75% (per annum, annual payments).
7. The current price on IRFs is $98.75 per $100 FV with a contract size of $500,000.The duration of the deliverable security is 10.00 yrs. Assume that the sensitivity of the futures and spot rates (b ratio) is equal to 0.95.

Group Number	Change in Rates (basis points)	Duration of IRF	b ratio
7	45	10.00	0.95