Reference no: EM131341646

Part I-

1. A government bond is currently selling for $1,195 and pays $75 per year in interest for 14 years when it matures. If the redemption value of this bond is $1,000, what is its yield to maturity if purchased today for $1,195?

2. Suppose the government bond described in problem 1 above is held for five years and then the savings institution acquiring the bond decides to sell it at a price of $940. Can you figure out the average annual yield the savings institution will have earned for its five-year investment in the bond?

3. U.S. Treasury bills are available for purchase this week at the following prices (based upon $100 par value) and with the indicated maturities.
a. $97.25, 182 days

b. $95.75, 270 days

c. $98.75, 91 days

Calculate the bank discount rate (DR) on each bill if it is held to maturity. What is the equivalent yield to maturity (sometimes called the bond-equivalent or coupon-equivalent yield) on each of these Treasury bills?

4. Farmville Financial reports a net interest margin of 2.75 percent in its most recent financial report, with total interest revenue of $95 million and total interest costs of $82 million. What volume of earning assets must the bank hold? Suppose the bank's interest revenue rise by 5 percent and interest costs and earning assets increase 9 percent. What will happen to Farmville's net interest margin?

5. If a credit union's net interest margin, which was 2.50 percent, increase 10 percent and its total assets, which stood originally at $575 million, rise by 25 percent from an initial level of 3 percent, what changes will occur in the bank's net interest margin?

Part II-

1. What kind of futures or options hedges would be called for in the following situations?
a. Market interest rates are expected to increase and your financial firm's asset-liability managers expect to liquidate a portion of their bond portfolio to meet customers' demands for funds in the upcoming quarter.

b. Your financial firm has interest-sensitive assets of $79 million and interest-sensitive liability of $88 million over the next 30 days, and market interest rates are expected to rise.

c. A survey of Tuskee Bank's corporation loan customers this month (January) indicates that on balance, this group of firms will need to draw $165 million from their credit lines in February and March, which is $65 million more than the bank's management has forecasted and prepared for. The bank's economist has predicted a significant increase in money market interest rates over the next 60 days

d. Monarch National Bank has interest-sensitive assets greater than interest-sensitive liability by $24 million. If interest rates fall (as suggested by data from the Federal Reserve Board), the bank's net interest margin may be squeezed due to the decrease in loan and security revenue.

e. Caufield Thrift Association finds that its assets have an average duration of 1.5 years and its liability have an average duration of 1.1 years. The ratio of liabilities to assets is .90. Interest rates are expected to increase by 50 basis points during the next six months.

2. Your Financial firm needs to borrow $500 million by selling time deposits with 180 day maturities. If interest rates on comparable deposits are currently at 3.5 percent. What is the cost of issuing these deposits? Suppose interest rates rise to 4.5 percent. What then will be the cost of these deposits? What position and types of futures contracts could be used to deal with this cost increase?

Part III-
1. Goodlife National Bank placed a group of 10,000 consumer loans bearing an average expected gross annual yield of 6 percent in a package to be securitized. The investment bank advising GoodLife estimate that the securities will sell a slight discount from par that results in a net interest cost to the issuer of 4.00 percent.

Based on recent experience with similar types of loans, the bank expects 3 percent of the packaged loans to default without any recovery for the lender and has agreed to set aside a cash reserve to cover this anticipated loss. Underwriting and advisory services provided by the investment banking firm will cost 0.5 percent. GoodLife will also seek a liquidity facility, costing 0.5 percent, and a credit guarantee if actual loan defaults should exceed the expected loan default rate, costing 0.6 percent. Please calculate residual income for GoodLife from this loan securitization.