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You are the senior analyst at the JSSE, the local regulator of banks. You have been given the below information for two banks, Bank A
You are the senior analyst at the JSSE, the local regulator of banks. You have been given the below information for two banks, Bank A and Bank B. Your boss is concerned that some banks are overly exposed to interest rate risk. Local interest rates are currently 10% Bank A $ 5,000,000.00 Duration $ 5.00 Liabili:ies 4,000,000.00 Duration 4.00 Assets 0 Equity Total 1,000,000.00 5,000,000.00 Total 5,000,000.00 Bank B $ $ 5,000,000.00 Duration 5.00 Liabilities 3,000,000.00 Duration 4.00 Assets Equity Total 2,000,000.00 5,000,000.00 Total 5,000,000.00 a. To measure exposure to interest rate risk, it is the policy of the regulator to use the leverage duration gap to indicate the impact of changes in interest rates on each bank's equity. Calculate the dollar value of the change in equity for each bank for a 1% increase in interest rates (that is interest rates increase from 10% to 11%). Show what the balance sheet looks like after the increase in interest rates. (10 points) b. The regulator considers a bank "in trouble" if the effect of a 1% increase in interest rates results in a fall in the bank's equity of more than 7%. a. Which of the two banks is in trouble? Show your answer. b. For the bank that is in trouble, incicate one change it can make it its balance sheet to fix the problem. (n calculation necessary) (3 points) c. You have decided to approach both bank, to have a discussion about how they manage their interest rate risk. In the meet ng with the executives from each bank, you got the understanding that both ban cs sought to manage interest rate risk through immunization of their portfolios hrough managing duration. Outline the three major factors that both executives have to manage in order to immunize their portfolios. (6 points) d. Identify and discuss two difficulties in appling the duration model to immunize the portfolio of a financial institution. (6 points) You are the senior analyst at the JSSE, the local regulator of banks. You have been given the below information for two banks, Bank A and Bank B. Your boss is concerned that some banks are overly exposed to interest rate risk. Local interest rates are currently 10% Bank A $ 5,000,000.00 Duration $ 5.00 Liabili:ies 4,000,000.00 Duration 4.00 Assets 0 Equity Total 1,000,000.00 5,000,000.00 Total 5,000,000.00 Bank B $ $ 5,000,000.00 Duration 5.00 Liabilities 3,000,000.00 Duration 4.00 Assets Equity Total 2,000,000.00 5,000,000.00 Total 5,000,000.00 a. To measure exposure to interest rate risk, it is the policy of the regulator to use the leverage duration gap to indicate the impact of changes in interest rates on each bank's equity. Calculate the dollar value of the change in equity for each bank for a 1% increase in interest rates (that is interest rates increase from 10% to 11%). Show what the balance sheet looks like after the increase in interest rates. (10 points) b. The regulator considers a bank "in trouble" if the effect of a 1% increase in interest rates results in a fall in the bank's equity of more than 7%. a. Which of the two banks is in trouble? Show your answer. b. For the bank that is in trouble, incicate one change it can make it its balance sheet to fix the problem. (n calculation necessary) (3 points) c. You have decided to approach both bank, to have a discussion about how they manage their interest rate risk. In the meet ng with the executives from each bank, you got the understanding that both ban cs sought to manage interest rate risk through immunization of their portfolios hrough managing duration. Outline the three major factors that both executives have to manage in order to immunize their portfolios. (6 points) d. Identify and discuss two difficulties in appling the duration model to immunize the portfolio of a financial institution. (6 points)
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