Question Three Answer all parts Show all your workings (a) Valley National Bank has assets consisting of $5.5 billion in cash, $70.0 billion of 5.0% fixed rate interest only mortgages (with annual payment and compounding) with an average life of 12.0 years (and currently trading at par). The Bank also has $15.0 billion of other loans with an approximate duration of 2.80. Valley National Bank has liabilities consisting of $69.0 billion in deposits with an approximate duration of 1.8463. (i) Using the duration gap (DG) method, calculate Valley National Bank's exposure to an unexpected 40bp parallel increase in interest rates. Explain your answer. (14 marks) (ii) Using the DG method, calculate what unexpected parallel increase in interest rates would completely eradicate Valley National Bank's equity? (3 marks) (b) Valley National Bank wishes to immunise its balance sheet against unexpected interest rate changes with a classic T-bond contract currently priced at $111.50 (in decimal form). The cheapest to deliver bond against this contract is a 16 year, 5.0% coupon bond currently priced to yield 4.5%. (i) Calculate the cost of the cheapest to deliver bond. (6 marks) (ii) How many futures contracts are necessary to immunise Valley National Bank's balance sheet? (7 marks) (Total: 30 marks) Question Three Answer all parts Show all your workings (a) Valley National Bank has assets consisting of $5.5 billion in cash, $70.0 billion of 5.0% fixed rate interest only mortgages (with annual payment and compounding) with an average life of 12.0 years (and currently trading at par). The Bank also has $15.0 billion of other loans with an approximate duration of 2.80. Valley National Bank has liabilities consisting of $69.0 billion in deposits with an approximate duration of 1.8463. (i) Using the duration gap (DG) method, calculate Valley National Bank's exposure to an unexpected 40bp parallel increase in interest rates. Explain your answer. (14 marks) (ii) Using the DG method, calculate what unexpected parallel increase in interest rates would completely eradicate Valley National Bank's equity? (3 marks) (b) Valley National Bank wishes to immunise its balance sheet against unexpected interest rate changes with a classic T-bond contract currently priced at $111.50 (in decimal form). The cheapest to deliver bond against this contract is a 16 year, 5.0% coupon bond currently priced to yield 4.5%. (i) Calculate the cost of the cheapest to deliver bond. (6 marks) (ii) How many futures contracts are necessary to immunise Valley National Bank's balance sheet? (7 marks) (Total: 30 marks)
