minimize interest rate risk within the nexl yeal 11. A bank\'s economics departm
ID: 2769709 • Letter: M
Question
minimize interest rate risk within the nexl yeal 11. A bank's economics department has just forecast accelerated growth in the eco east with GDP expected to grow at a 4.5 percent annual growth rate for at lty two years. What are the implications of this economic forecast for ant vestm officer? What types of securities should the officer think most seriously about ad.chts to the investment portfolio? Why? Suppose the bank holds a security portfolio simil. about add rttolio sim ing o similar ot securities to that described in Table 10-3 for all insured U.S. banks. Which types of might the investments officer want to think seriously about selling if the projected economic expansion takes place? What losses might occur and how could these losses be minimized?Explanation / Answer
Answer: This economic forecast suggests that the current yield curve should be upward sloping and that interest rates will rise over the next two years. In addition, loan demand should increase as the economy expands suggesting that the bank may have to sell some of its investment portfolio in the future to meet that demand. The investment officer would probably shorten the maturities of the investment portfolio. An exception to this might be if the investment officer wants to ride the yield curve by selling shorter term securities at a premium today and replacing them with longer maturity securities with higher coupon rates. However, the investment manager must take into account the risk of capital losses for the future with this strategy. The investment manager can reduce his risks with the appropriate hedging tools .
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