Your employer has asked you to examine the interest-rate risk of your bank relat
ID: 2735914 • Letter: Y
Question
Your employer has asked you to examine the interest-rate risk of your bank relative to your direct competition. Management is concerned that interest rates will fall by the end of the year and wants to see what would happen to the relative profitability of the firm if the decline actually occurs.
Interest-rate risk depends on each bank's relative position of interest-sensitive assets and liabilities. You begin the analysis by collecting the information and estimates.
a.) Decline by 3%
b.) Increase by 3%
Bank Balance Sheet Competition Your Firm Amount Smillions Duration ears Amount Smillions Duration ears 4 0.0 0.0 Reserves and cash items Securities 0.6 1.6 5.0 0.3 1.2 4.0 4 Less than 1 year 1-2 years Greater than 2 years 0.9 4.4 Residential mortgages Variable-rate Fixed-rate (30 years) 0.4 5.5 17 30 30 0.6 1.4 5.4 0.0 Commerical loans 0.9 1.8 6.0 0.0 Less than 1 year 1-2 years 13 31 Greater than 2 years Physical capital 25 10 Liabilities Checkable deposits Money market deposit accounts Savings deposits CDs 1.0 0.5 1.0 14 10 12 6 1.0 0.6 1.0 16 0.4 0.3 1.1 2.9 0.0 12 14 10 10 14 0.6 0.5 1.8 2.2 0.0 Variable-rate Less than 1 year 19 1-2 years Greater than 2 years 15 10 12 39 Fed funds Less than 1 year 1-2 years Greater than 2 years 0.4 1.2 2.9 18 12 31 0.7 1.8 3.8Explanation / Answer
As no specific information is provided, we assume that the question asks for the effect of interest rate changes on profit during next 12 months.
Total of interest-rate sensitive assets = Residential mortgage variable-rate + Commercial loan greater than 2 Years
Your firm = 9 + 55 = 64
Competition = 21 + 30 = 51
Total of interest-rate sensitive liabilities = CDs variable rate + Borrowings greater than 2 Years
Your firm = 6 + 39 = 45
Competition = 12 + 31 = 43
Gap = Interest rate sensitive assets – interest rate sensitive liabilities
Your firm = 64 – 45 = 19
Competition = 51 – 43 = 8
Net effect on profits = Change in interest rate x Gap
Interest rate increase:
Your firm = 0.03 x 19 million = $570,000 (So, profit will increase by $570,000)
Competition = 0.03 x 8 million = $240,000 (So, profit will increase by $240,000)
Interest rate decline:
Your firm = -0.03 x 19 million = -$570,000 (So, profit will decline by $570,000)
Competition = -0.03 x 8 million = -$240,000 (So, profit will decline by $240,000)
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