Question 6

A bank wants to use direct refinancing to manage its duration gap, D_G. Currently, for its assets, Loans = $22 million and Cash = $6 million. Equity = $4 million. Average D_A = 2.75 yrs, and average D_L = 4 yrs.

a) Should the bank buy loans with cash or sell existing loans for cash to reduce its interest rate risk?

b) What is the duration of the banks existing loans?

c) How much cash will be used to eliminate the banks interest rate exposure if the loan available on the market has a duration of 7.6 years?