FIN 440 Exam ch.8

A bank has the following balance sheet: Assets Avg. Rate Rate sensitive $550,000 7.75% Fixed rate 755,000 8.75 Nonearning 265,000 Total $1,570,000 Liabilities/Equity Avg. Rate Rate sensitive $375,000 6.25% Fixed rate 805,000 7.50 Nonpaying 390,000 Total $1,570,000 Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis points. b. Assuming the bank does not change the composition of its balance sheet, calculate the resulting change in the bank's interest income, interest expense, and net interest income.

Change II = $550,000(0.0045) = $2,475 Change IE = $375,000(0.0035) = $1,312.50 Change NII = $2,475 - $1,312.50 = $1,162.50

An FI finances a $250,000 2-year fixed-rate loan with a $200,000 1-year fixed-rate CD. Use the repricing model to determine (a) the FI's repricing (or funding) gap using a 1-year maturity bucket, and (b) the impact of a 100 basis point (0.01) decrease in interest rates on the FI's annual net interest income? A) $0; $0 B) -$200,000; +$2,000 C) -$200,000; -$2,000 D) +$50,000; $500 E) $200,000; $1,000

B) -$200,000; +$2,000 -200,000*(-1%)=2000

Use the following to answer question 2-year commercial loans 10% 1-year CDs 7% annual Annual fixed rate at par $600M Fixed Rate at par $900M 1-year treasury bills $400M Net worth $100M What is the repricing gap over the 1-year maturity bucket? A) +$100 million B) -$500 million C) $100 million D) +$500 million E) $900 million

B) -$500 million

Consider the following balance sheet for WatchoverU Savings, Inc. (in millions): Assets Floating-rate mortgages (currently 10% annually) $50 30-year fixed-rate loans (currently 7% annually) $50 Total assets $100 Liabilities and Equity 1-year time deposits (currently 6% annually) $70 3-year time deposits (currently 7% annually) $20 Equity $10 Total liabilities & equity $100 a. What is WatchoverU's expected net interest income (for year 2) at year-end?

Current expected interest income: $50m(0.10) + $50m(0.07) = $8.5m. Expected interest expense: $70m(0.06) + $20m(0.07) = $5.6m. Expected net interest income : $8.5m ‑ $5.6m = $2.9m.

Use the following to answer question 2-year commercial loans 10% 1-year CDs 7% annual Annual fixed rate at par $600M Fixed Rate at par $900M 1-year treasury bills $400M Net worth $100M If all interest rates decrease by 15 basis points, what is the expected impact on the FI's net interest income? (Hint: Use the repricing model to answer this question.) A) +$150,000 B) $150,000 C) -$750,000 D) +$750,000 E) No change.

D) +$750,000 -500*(-0.15%)=0.75million dollars

In the 1980s, interest rate risk exposure became A) less of a problem for FIs because of the decreased volatility of interest rates. B) more of a problem for FIs because of the change in the Federal Reserve's conduct of monetary policy. C) less of a problem for FIs because of the change in the Federal Reserve's conduct of monetary policy. D) more of a problem for FIs because of the decreased volatility of interest rates. E) more of a problem for FIs because of the thrift crisis.

B) more of a problem for FIs because of the change in the Federal Reserve's conduct of monetary policy.

A bank has the following balance sheet: Assets Avg. Rate Rate sensitive $550,000 7.75% Fixed rate 755,000 8.75 Nonearning 265,000 Total $1,570,000 Liabilities/Equity Avg. Rate Rate sensitive $375,000 6.25% Fixed rate 805,000 7.50 Nonpaying 390,000 Total $1,570,000 Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis points. a. Calculate the bank's CGAP and gap ratio.

Repricing GAP = $550,000 - $375,000 = $175,000 Gap ratio = $175,000/$1,570,000 = 11.15%

Consider the following balance sheet for WatchoverU Savings, Inc. (in millions): Assets Floating-rate mortgages (currently 10% annually) $50 30-year fixed-rate loans (currently 7% annually) $50 Total assets $100 Liabilities and Equity 1-year time deposits (currently 6% annually) $70 3-year time deposits (currently 7% annually) $20 Equity $10 Total liabilities & equity $100 c. Using the cumulative repricing gap model, what is the expected net interest income (for year 2) for a 2 percent increase in interest rates?

WatchoverU's repricing or funding gap is $50m ‑ $70m = ‑$20m. The change in net interest income using the funding gap model is (‑$20m)(0.02) = ‑$0.4m.

Consider the following balance sheet positions for a financial institution: · Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million · Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million · Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million B) Calculate the impact on net interest income on each of the above situations assuming a 1 percent decrease in interest rates.

· Change NII = ($100 million)(-0.01) = -$1.0 million, or -$1,000,000. · Change NII = (-$50 million)(-0.01) = +$0.5 million, or $500,000. · Change NII = ($10 million)(-0.01) = -$0.1 million, or -$100,000.

A positive gap implies that an increase in interest rates will cause an increase in net interest income. True/False

True

All FIs tend to mismatch the maturities of their assets and liabilities to some extent. True/False

True

In general, the interest rate spread (spread effect) between rate-sensitive assets and rate sensitive liabilities is positively related to the change in net interest income. True/False

True

The economic insolvency of many thrift institutions during the 1980s was due, at least in part, to major increases in interest rates. True/False

True

The repricing gap approach calculates the gaps in each maturity bucket by subtracting the rate sensitive liabilities (RSL) from the rate sensitive assets (RSA) on the balance sheet. True/False

True

The repricing model is a simplistic approach to focusing on the exposure of net interest income to changes in market levels of interest rates for given maturity periods. True/False

True

Consider the following balance sheet for WatchoverU Savings, Inc. (in millions): Assets Floating-rate mortgages (currently 10% annually) $50 30-year fixed-rate loans (currently 7% annually) $50 Total assets $100 Liabilities and Equity 1-year time deposits (currently 6% annually) $70 3-year time deposits (currently 7% annually) $20 Equity $10 Total liabilities & equity $100 b. What will expected net interest income (for year 2) be at year-end if interest rates rise by 2 percent?

After the 2 percent interest rate increase, net interest income is: 50(0.12) + 50(0.07) ‑ 70(0.08) ‑ 20(.07) = $9.5m ‑ $7.0m = $2.5m, a decline of $0.4m.

Consider the following balance sheet for WatchoverU Savings, Inc. (in millions): Assets Floating-rate mortgages (currently 10% annually) $50 30-year fixed-rate loans (currently 7% annually) $50 Total assets $100 Liabilities and Equity 1-year time deposits (currently 6% annually) $70 3-year time deposits (currently 7% annually) $20 Equity $10 Total liabilities & equity $100 d. What will expected net interest income (for year 2) be at year-end if interest rates on RSAs increase by 2 percent but interest rates on RSLs increase by 1 percent? Is it reasonable for changes in interest rates on RSAs and RSLs to differ? Why?

After the unequal rate increases, net interest income will be 50(0.12) + 50(0.07) - 70(0.07) - 20(0.07) = $9.5m ‑ $6.3m = $3.2m, an increase of $0.3m. It is not uncommon for interest rates to adjust in an unequal manner on RSAs versus RSLs. Interest rates often do not adjust solely because of market pressures. In many cases, the changes are affected by decisions of management. Thus, you can see the difference between this answer and the answer for part a.

If an FI's repricing gap is less than zero, then A) it is deficient in its required reserves. B) it is deficient in its capital ratio requirement. C) its liability costs are more sensitive to changing market interest rates than are its asset yields. D) its liability costs are less sensitive to changing market interest rates than are its asset yields. E) the duration of the FI's liabilities exceeds the duration of FI's assets.

C) its liability costs are more sensitive to changing market interest rates than are its asset yields.

A bank with a negative repricing (or funding) gap faces reinvestment risk. True/False

False

If interest rates decrease 50 basis points (0.5 percent) for an FI that has a gap of $5 million, the expected change in net interest income is +$25,000. True/False

False

Use the following information about a hypothetical government security dealer named M. P. Jorgan. Market yields are in parenthesis, and amounts are in millions. Assets Cash $10 1-month T-bills (7.05%) 75 3-month T-bills (7.25%) 75 2-year business loans (7.50%) 50 8-year mortgage loans (8.96%) 100 5-year munis (floating rate) (8.20% reset every 6 months) 25 Total assets $335 Liabilities and Equity Overnight repos $170 Subordinated debt 7-year fixed rate (8.55%) 150 Equity 15 Total liabilities & equity $335 b. What is the impact over the next 30 days on net interest income if interest rates increase 50 basis points? Decrease 75 basis points?

If interest rates increase 50 basis points, net interest income will decrease by $475,000. DNII = CGAP(DR) = ‑$95m(0.005) = -$0.475m. If interest rates decrease by 75 basis points, net interest income will increase by $712,500. DNII = CGAP(DR) = ‑$95m(-0.0075) = $0.7125m.

Use the following information about a hypothetical government security dealer named M. P. Jorgan. Market yields are in parenthesis, and amounts are in millions. Assets Cash $10 1-month T-bills (7.05%) 75 3-month T-bills (7.25%) 75 2-year business loans (7.50%) 50 8-year mortgage loans (8.96%) 100 5-year munis (floating rate) (8.20% reset every 6 months) 25 Total assets $335 Liabilities and Equity Overnight repos $170 Subordinated debt 7-year fixed rate (8.55%) 150 Equity 15 Total liabilities & equity $335 d. If runoffs are considered, what is the effect on net interest income at year-end if interest rates increase 50 basis points? Decrease 75 basis points?

If interest rates increase 50 basis points, net interest income will increase by $175,000. DNII = CGAP(DR) = $35m(0.005) = $0.175m. If interest rates decrease 75 basis points, net interest income will decrease by $262,500. DNII = CGAP(DR) = $35m(-0.0075) = -$0.2625m.

Use the following information about a hypothetical government security dealer named M. P. Jorgan. Market yields are in parenthesis, and amounts are in millions. Assets Cash $10 1-month T-bills (7.05%) 75 3-month T-bills (7.25%) 75 2-year business loans (7.50%) 50 8-year mortgage loans (8.96%) 100 5-year munis (floating rate) (8.20% reset every 6 months) 25 Total assets $335 Liabilities and Equity Overnight repos $170 Subordinated debt 7-year fixed rate (8.55%) 150 Equity 15 Total liabilities & equity $335 a. What is the repricing gap if the planning period is 30 days? 3 months? 2 years? Recall that cash is a non-interest-earning asset.

Repricing gap using a 30-day planning period = $75m ‑ $170m = ‑$95 million. Repricing gap using a 3-month planning period = ($75m + $75m) ‑ $170m = -$20 million. Reprising gap using a 2-year planning period = ($75m + $75m + $50m + $25m) ‑ $170m = +$55 million.

A bank with a negative repricing (or funding) gap faces refinancing risk. True/False

True

A bank has the following balance sheet: Assets Avg. Rate Rate sensitive $550,000 7.75% Fixed rate 755,000 8.75 Nonearning 265,000 Total $1,570,000 Liabilities/Equity Avg. Rate Rate sensitive $375,000 6.25% Fixed rate 805,000 7.50 Nonpaying 390,000 Total $1,570,000 Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis points. c. Explain how the CGAP and spread effects influenced the change in net interest income.

The CGAP affect worked to increase net interest income. That is, the CGAP was positive while interest rates increased. Thus, interest income increased by more than interest expense. The result is an increase in NII. The spread effect also worked to increase net interest income. The spread increased by 10 basis points. According to the spread affect, as spread increases, so does net interest income.

Consider the following balance sheet positions for a financial institution: · Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million · Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million · Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million C) What conclusion can you draw about the repricing model from these results?

The FIs in parts (1) and (3) are exposed to interest rate declines (positive repricing gap), while the FI in part (2) is exposed to interest rate increases. The FI in part (3) has the lowest interest rate risk exposure since the absolute value of the repricing gap is the lowest, while the opposite is true for the FI in part (1).

Use the following information about a hypothetical government security dealer named M. P. Jorgan. Market yields are in parenthesis, and amounts are in millions. Assets Cash $10 1-month T-bills (7.05%) 75 3-month T-bills (7.25%) 75 2-year business loans (7.50%) 50 8-year mortgage loans (8.96%) 100 5-year munis (floating rate) (8.20% reset every 6 months) 25 Total assets $335 Liabilities and Equity Overnight repos $170 Subordinated debt 7-year fixed rate (8.55%) 150 Equity 15 Total liabilities & equity $335 c. The following one-year runoffs are expected: $10 million for two-year business loans and $20 million for eight-year mortgage loans. What is the one-year repricing gap?

The repricing gap over the 1-year planning period = ($75m. + $75m. + $10m. + $20m. + $25m.) ‑ $170m. = +$35 million.

What is the spread effect?

The spread effect is the effect that a change in the spread between rates on RSAs and RSLs has on net interest income as interest rates change. The spread effect is such that, regardless of the direction of the change in interest rates, a positive relation exists between changes in the spread and changes in NII. Whenever the spread increases (decreases), NII increases (decreases).

Consider the following balance sheet positions for a financial institution: · Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million · Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million · Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million A) Calculate the repricing gap and the impact on net interest income of a 1 percent increase in interest rates for each position.

· Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million. Repricing gap = RSA ‑ RSL = $200 ‑ $100 million = +$100 million. DNII = ($100 million)(0.01) = +$1.0 million, or $1,000,000. · Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million. Repricing gap = RSA ‑ RSL = $100 ‑ $150 million = -$50 million. DNII = (-$50 million)(0.01) = -$0.5 million, or -$500,000. · Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million. Repricing gap = RSA ‑ RSL = $150 ‑ $140 million = +$10 million. DNII = ($10 million)(0.01) = +$0.1 million, or $100,000.