Reference no: EM133069380
The Accounts Department of a major bank forecasts an increase in interest rates (?R) of 25 bps and the Senior Management of the bank is concerned about the impact of this possible interest rate increase on the performances of the bank and its balance sheet.
|
Assets
|
($million)
|
Market yields %
|
Duration
|
|
Cash
Interbank lending
3-month T-notes
2-year T-bonds
5-year T-bonds
10-year T-bonds
Consumer loans
Business loans
Fixed-rate mortgages
Variable-rate mortgages
Premises & equipment
|
250
850
600
500
750
1,000
800
450
1,300
700
250
|
-
5.00
2.50
3.25
5.00
5.75
6.00
5.80
5.85
3.85
-
|
-
0.02
0.25
2.00
*
*
2.50
6.58
19.50
0.50
-
|
|
Total assets
|
7,450
|
|
|
|
Liability & Equity
|
|
|
|
|
Demand deposits
Savings accounts
3-month CDs
6-month CDs
1-year CDs
5-year CDs
Interbank borrowings
Commercial paper
Subordinated debt: fixed rate
|
400
540
425
400
750
1,950
985
600
500
|
-
1.50
2.00
2.50
3.25
4.00
4.00
5.05
7.25
|
-
0.50
0.25
0.50
*
*
0.02
0.45
6.65
|
|
Total liabilities
|
6,550
|
|
|
|
Equity
|
900
|
|
|
|
Total liabilities and equity
|
7,450
|
|
|
Notes: Please use the following notes in conjunction with the balance sheet data.
- The coupon rate paid on 5-year T-bonds is 4.50% (per annum). The coupon payment is received semi-annually.
- The coupon rate paid on 10-year T-bonds is 5.50% (per annum) and the coupon payment is received annually.
- Variable rate mortgages are repriced at every six months.
- Fixed rate mortgages are for five-year period.
- 1-year CDs have been issued with a coupon rate of 3.00% (per annum, semi-annual payments)
- 5-year CDs have been issued with a coupon rate of 3.75% (per annum, annual payments).
- The current price on IRFs is $98.75 per $100 FV with a contract size of $500,000. The duration of the deliverable security is 9.0 yrs. Assume that the sensitivity of the futures and spot rates (b ratio) is equal to 0.75.
1. Given that the Accounts Department has predicted an increase in rates, analyse the extent to which our bank is exposed to interest rate risk/s, if any;
2. Measure the interest rate risk using the duration model. Construct the portfolio duration of assets and liabilities, estimate the duration gap, and then apply duration gap analysis to estimate the change in net worth arising from the interest change;