Estes Park National Bank holds assets and liabilities whose average durations an

Question

Estes Park National Bank holds assets and liabilities whose average durations and dollar amounts are as shown in this table:

a.) What is the weighted average duration of Estes Park’s asset portfolio and liability portfolio?

b.) What is the leverage-adjusted duration gap?

c.) Suppose market interest rates increase from 3.25 percent to 4.25 percent, by how much would Estes Park’s net worth change?

d.) Alternatively, if interest rates decline from 3.25 percent to 2.50 percent, by how much would Estes Park’s net worth change?   

Asset and Liability Items Avg. Duration (years) Dollar Amount (millions) Investment Grade Bonds 15.00 $65.00 Commercial Loans 3.00 $400.00 Consumer Loans 7.00 $250.00 Deposits 1.25 $600.00 Nondeposit Borrowings 0.50 $50.00

Explanation / Answer

Answer:a) The weighted average duration of Estes Park’s asset portfolio is:

=1.25*600+0.50*50/650

=1.19 years

The weighted average duration of Estes Park’s Liability portfolio is:

=15*65+3*400+7*250/715=5.49 years

Answer:b) The leverage-adjusted duration gap is:

=5.49-1.19=4.3 years

Answer:c) It is exposed to interest rate risk. If interest rates rise, net worth will decline because the average maturity of the assets is higher than the average maturity of the liabilities.

Answer:d) It is exposed to interest rate risk. If interest rates falls, net worth will increase because the average maturity of the assets is higher than the average maturity of the liabilities.

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