Question 8 (3 Marks)

Southern Banks asset and liability manager is nervous about how basis risk might affect its net interest income over a 3-month period. He determines correlations of response for each relevant account type to a reference short-term interest rate to be:

For Assets

Liquid investments	0.90
Investment securities	0.70
Loans	0.60

For Liabilities

At-call deposits	0.26
savings	0.40
Money market deposit accounts	0.60
borrowings	0.50

The dollar value of rate sensitive assets and liabilities and the unadjusted repricing gap is contained in the following Earnings at risk table.

a) Copy and paste the table below into the answer panel. Fill in the blank cells to determine the value of the adjusted repricing gap (i.e., adjusted for basis risk). Alternatively, you could copy and paste (as text , not html) the tables into Excel, populate, then paste into the answer panel. (2 marks)

Earnings at risk statement ($ million)

Rate-sensitive assets (0-3 month)	Balance sheet gap	Correlation coefficient	Adjusted gap
Liquid investments	900
Investment securities	320
Loans	2500
Total	3720
Rate-sensitive liabilities (0 - 3 month)
At-call deposits	1450
Savings deposits	450
Money market deposit accounts	2200
Borrowed funds	900
Total	5000
3-month Gap	-1280

b) If interest rates are forecast to rise over the next 3 months, how might the bank adjust its balance sheet to benefit from the rate rise? Why? (1 Mark)