Consider the following bank balance sheet (fixed rates and pure discount securit
ID: 2777702 • Letter: C
Question
Consider the following bank balance sheet (fixed rates and pure discount securities unless indicated otherwise). Interest rates on liabilities are 10 percent and on assets are 12 percent. Assets Prime-Rate Loans (rates set daily) 2-Year Car Loans 30-Year Mortgages Total Assets $m Duration (years) Liabilities and Equity Super Now Checking Accounts (rates set daily) 6-Month Certificates of Deposit 3-Year Certificates of Deposit Total Liabilites $m 100 40 25 165 10 Duration (years) 50 65 60 175 1.0 1.0 7.0 ? 1.0 0.5 3.0 ? -- same amount). Equity (E) a. What is the duration of assets, DA, liabilites, DL, and Equity, E. b. The bank will benefit or be hurt if all interest rates rise (assume by the c. Compute the repricing gap for the bank using those assets and liabilities repricing or maturing in 2 years or less. From this information, will the bank be hurt or benefit by a 200 basis point rise in interest rates on assets and liabilities? d. If the bank gets an additional $100 in a 6-month certificate of deposit, what investments (using the above portfolio possibilities) should it make to control interest rate risk ( y = ï¿12 200 basis point change in all interest rates) by changing the duration of its portfolio? State the advantages and disadvantages of using net worth immunization and asset/liability duration as a means of controlling interest rate risk. Define your terms.
Explanation / Answer
Year 0 1 2 3 4 5 Equipment Cost (600,000) Net Revenue 300,000 315,000 330,750 347,288 364,652 Less :Labor/Maintenance costs (100,000) (105,000) (110,250) (115,763) (121,551) Utilities Costs 10,000 10,500 11,025 11,576 12,155 Supplies Incremental overhead 5,000 5,000 5,000 5,000 5,000 Operating Income (600,000) 215,000 225,500 236,525 248,101 260,256 Equipment Salvage Value 200,000 Net Cash Flow (600,000) 215,000 225,500 236,525 248,101 460,256 PV of cash flow at 10% (600,000) 195,455 186,364 177,705 169,456 285,783 Npv 414,762 IRR 31.3%
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