Use the following definitions and values: r = 0.03 (constant real rate of interest) p1 = 0.05 (period 1 rate of inflation) (a) p2e = 0.10 (expected period 2 rate of inflation) (b) p2e = 0.15 (expected period 2 rate of inflation) 1y1 = current yield on one-year securities 2y1e = Expected period 2 yield on one-year securities 1y2 = current yield on two-year securities Pure Expectations Hypothesis (1 + 1ym) = [(1 + 1y1)(1 + 2y1e). . .(1 + my1e)]1/m and jy1e = the forward rate, jf1. (15) 5. Consider the following bank balance sheet (fixed rates and pure discount securities unless indicated otherwise). Interest rates on liabilities are 10 percent and on assets are 12 percent. Assets $m Duration (years) Liabilities and Equity $m Duration (years) Prime-Rate Loans (rates set daily) 50 1.0 Super Now Checking Accounts (rates set daily) 100 1.0 2-Year Car Loans 65 1.0 6-Month Certificates of Deposit 40 0.5 30-Year Mortgages 60 7.0 3-Year Certificates of Deposit 25 3.0 Total Assets 175 ? Total Liabilites 165 ? Equity (E) 10 -- a. What is the duration of assets, DA, liabilites, DL, and Equity, E. b. The bank will benefit or be hurt if all interest rates rise (assume by the same amount). c. Compute the repricing gap for the bank using those assets and liabilities repricing or maturing in 2 years or less. From this information, will the bank be hurt or benefit by a 200 basis point rise in interest rates on assets and liabilities? d. If the bank gets an additional $100 in a 6-month certificate of deposit, what investments (using the above portfolio possibilities) should it make to control interest rate risk ( y = 200 basis point change in all interest rates) by changing the duration of its portfolio? State the advantages and disadvantages of using net worth immunization and asset/liability duration as a means of controlling interest rate risk. Define your terms.

E y D y L A D y A A A L L [ ( ) ( ) ] 1 1 If E = 0: D y L A D y A A L L (1 ) (1 ) or D L A D y y A L A L ( ) ( ) 1 1 E = change in market value of the portfolio, DA = duration of assets, DL = duration of liabilities, DE = duration of the portfolio or equity, E = market value of equity, L = market value of liabilities, A = market value of assets, and y = change in interest rates.

Use the following definitions and values: 1=0.03 (constant real rate of interest) pl = 0.05 (period 1 rate of inflation) (a) p2e = 0.10 (expected period 2 rate of inflation) (b) p2e = 0.15 (expected period 2 rate of inflation) lyl = current yield on one-year securities 2yle = Expected period 2 yield on one-year securities ly2 = current yield on two-year securities Pure Expectations Hypothesis (1 + lym) = [(1 + 1y1)(1 + 2yle)...(1 + myle)]1/m and jyle= the forward rate, jfi. (15) 5. Consider the following bank balance sheet (fixed rates and pure discount securities unless indicated otherwise). Interest rates on liabilities are 10 percent and on assets alle 12 percent. Sm Duration (years) 100 1.0 Duration Assets Sm Liabilities and Equity (years) Prime-Rate Loans (rates 50 1.0 Super Now Checking Accounts set daily) (rates set daily) 2-Year Car Loans 65 1.0 6-Month Certificates of Deposit 30-Year Mortgages 60 7.0 3-Year Certificates of Deposit Total Assets 175 ? Total Liabilites Equity (E) a. What is the duration of assets, DA, liabilites, DL, and Equity, E. 0.5 3.0 40 25 165 10 ? b. The bank will benefit or be hurt if all interest rates rise (assume by the same amount). c. Compute the repricing gap for the bank using those assets and liabilities repricing or maturing in 2 years or less. From this information, will the bank be hurt or benefit by a 200 basis point rise in interest rates on assets and liabilities? d. If the bank gets an additional $100 in a 6-month certificate of deposit, what investments (using the above portfolio possibilities) should it make to control interest rate risk (A y=12 200 basis point change in all interest rates) by changing the duration of its portfolio? State the advantages and disadvantages of using net worth immunization and asset/liability duration as a means of controlling interest rate risk. Define your terms. L DY AE=- Ayla+ya) A (1+y) JA If AE = 0; DA L DL (1+y:) A (1+y;) or DA = L D, (1+ y2) A (1+yL) A E = change in market value of the portfolio, DA = duration of assets, DL = duration of liabilities, DE = duration of the portfolio or equity, E = market value of equity, L = market value of liabilities, A= market value of assets, and Ay= change in interest rates. Use the following definitions and values: 1=0.03 (constant real rate of interest) pl = 0.05 (period 1 rate of inflation) (a) p2e = 0.10 (expected period 2 rate of inflation) (b) p2e = 0.15 (expected period 2 rate of inflation) lyl = current yield on one-year securities 2yle = Expected period 2 yield on one-year securities ly2 = current yield on two-year securities Pure Expectations Hypothesis (1 + lym) = [(1 + 1y1)(1 + 2yle)...(1 + myle)]1/m and jyle= the forward rate, jfi. (15) 5. Consider the following bank balance sheet (fixed rates and pure discount securities unless indicated otherwise). Interest rates on liabilities are 10 percent and on assets alle 12 percent. Sm Duration (years) 100 1.0 Duration Assets Sm Liabilities and Equity (years) Prime-Rate Loans (rates 50 1.0 Super Now Checking Accounts set daily) (rates set daily) 2-Year Car Loans 65 1.0 6-Month Certificates of Deposit 30-Year Mortgages 60 7.0 3-Year Certificates of Deposit Total Assets 175 ? Total Liabilites Equity (E) a. What is the duration of assets, DA, liabilites, DL, and Equity, E. 0.5 3.0 40 25 165 10 ? b. The bank will benefit or be hurt if all interest rates rise (assume by the same amount). c. Compute the repricing gap for the bank using those assets and liabilities repricing or maturing in 2 years or less. From this information, will the bank be hurt or benefit by a 200 basis point rise in interest rates on assets and liabilities? d. If the bank gets an additional $100 in a 6-month certificate of deposit, what investments (using the above portfolio possibilities) should it make to control interest rate risk (A y=12 200 basis point change in all interest rates) by changing the duration of its portfolio? State the advantages and disadvantages of using net worth immunization and asset/liability duration as a means of controlling interest rate risk. Define your terms. L DY AE=- Ayla+ya) A (1+y) JA If AE = 0; DA L DL (1+y:) A (1+y;) or DA = L D, (1+ y2) A (1+yL) A E = change in market value of the portfolio, DA = duration of assets, DL = duration of liabilities, DE = duration of the portfolio or equity, E = market value of equity, L = market value of liabilities, A= market value of assets, and Ay= change in interest rates