Your employer has asked you to examine the interest-rate risk of your bank relat

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.

4.Using the net worth formula, if interest rates rise by 3%, what will be the expected change in the market value of net worth for

a.Your firm?

b.Your competition?

Assume that initial interest rate was 10%.

5.What would your firm need to do

a.To eliminate the income gap using adjustments to rate-sensitive assets?

b.To immunize the market value of net worth from interest-rate risk using duration?

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 3.8

Explanation / Answer

4) Net Worth = Total assets - Total liabilities

Firms Asset (in million)

Cash = 3

Securities 14

Residential mortages= 24

Commercial Loans = 99

Physical capital = 10

Total Assets = 150

Firms Liabilities (in millions)

Checkable deposits = 10

Money market deposit accounts = 5

Saving Deposits = 12

Commercial Deposits = 38

Fed Funds = 10

Borrowings = 60

Total Liabilities = 135

Net worth of the firm = 150-135 = 15

Competition Firm Assets (in million)

Cash = 4

Securities 19

Residential mortages= 38

Commercial Loans = 82

Physical capital = 25

Total Assets = 168

Comeptition Liabilities (in millions)

Checkable deposits = 14

Money market deposit accounts = 9

Saving Deposits = 16

Commercial Deposits = 46

Fed Funds = 14

Borrowings = 61

Total Liabilities = 160

Net worth of theCompetition Firm = 168 -160 = 8

5) A part

The bank manager attempt to abbreviate the length of the bank's resources for increment their rate affectability either by acquiring resources of shorter development or by changing over settled rate advances into movable rate advances.

The bank administrator may choose to inoculate the market estimation of the bank's total assets totally from loan fee chance by changing resources and liabilities with the goal that the span hole is equivalent to zero.

B part) For given changes in interest rates, the change in the market value of net worth of an FI is equal to the difference between the changes in the market value of the assets and market value of the liabilities.

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