Reference no: EM131138499
Answer the following question given below:
1. How do monetary policy actions made by the Federal Reserve impact interest rates?
2. What is the repricing gap? In using this model to evaluate interest rate risk, what is meant by rate sensitivity? On what financial performance variable does the repricing model focus? Explain.
3. What is a maturity bucket in the repricing model? Why is the length of time selected for repricing assets and liabilities important when using the repricing model?
4. What is the CGAP effect? According to the CGAP effect, what is the relation between changes in interest rates and changes in net interest income when CGAP is positive? When CGAP is negative?
5. Consider the following balance sheet positions for a financial institution:
• Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million
• Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million
• Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million
a. Calculate the repricing gap and the impact on net interest income of a 1 percent increase in interest rates for each position.
b. Calculate the impact on net interest income on each of the above situations assuming a 1 percent decrease in interest rates.
c. What conclusion can you draw about the repricing model from these results?
6. What are the reasons for not including demand deposits as rate-sensitive liabilities in the repricing analysis for a commercial bank? What is the subtle but potentially strong reason for including demand deposits in the total of rate sensitive liabilities? Can the same argument be made for passbook savings accounts?
7. What is the spread effect?
8. Use the following information about a hypothetical government security dealer named M.P. Jorgan. Market yields are in parenthesis, and amounts are in millions.
a. What is the repricing gap if the planning period is 30 days? 3 months? 2 years? Recall that cash is a non-interest-earning asset.
million.
b. What is the impact over the next 30 days on net interest income if interest rates increase 50 basis points? Decrease 75 basis points?
The following one-year runoffs are expected: $10 million for two-year T-notes and $20 million for eight-year T-notes. What is the one-year repricing gap?
d. If runoffs are considered, what is the effect on net interest income at year-end if interest rates increase 50 basis points? Decrease 75 basis points?
9. A bank has the following balance sheet:
Assets Avg. Rate Liabilities/Equity Avg. Rate
Rate sensitive $550,000 7.75% Rate sensitive $375,000 6.25%
Fixed rate 755,000 8.75 Fixed rate 805,000 7.50
Nonearning 265,000 Nonpaying 390,000
Total $1,570,000 Total $1,570,000
Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis points.
a. Calculate the bank's repricing GAP and gap ratio.
b. Assuming the bank does not change the composition of its balance sheet, calculate the resulting change in the bank's interest income, interest expense, and net interest income.
Explain how the CGAP and spread effects influenced the change in net interest income.
10. A bank has the following balance sheet:
Assets Avg. Rate Liabilities/Equity Avg. Rate
Rate sensitive $550,000 7.75% Rate sensitive $575,000 6.25%
Fixed rate 755,000 8.75 Fixed rate 605,000 7.50
Nonearning 265,000 Nonpaying 390,000
Total $1,570,000 Total $1,570,000
Suppose interest rates fall such that the average yield on rate-sensitive assets decreases by 15 basis points and the average yield on rate-sensitive liabilities decreases by 5 basis points.
a. Calculate the bank's CGAP and gap ratio.
b. Assuming the bank does not change the composition of its balance sheet, calculate the resulting change in the bank's interest income, interest expense, and net interest income.
c. The bank's CGAP is negative and interest rates decreased, yet net interest income decreased. Explain how the CGAP and spread effects influenced this decrease in net interest income.
11. The balance sheet of A. G. Fredwards, a government security dealer, is listed below. Market yields are in parentheses, and amounts are in millions.
Assets Liabilities and Equity
Cash $20 Overnight repos $340
1-month T-bills (7.05%) 150 Subordinated debt
3-month T-bills (7.25%) 150 7-year fixed rate (8.55%) 300
2-year T-notes (7.50%) 100
8-year T-notes (8.96%) 200
5-year munis (floating rate)
(8.20% reset every 6 months) 50 Equity 30
Total assets $670 Total liabilities and equity $670
a. What is the repricing gap if the planning period is 30 days? 3 month days? 2 years?
b. What is the impact over the next three months on net interest income if interest rates on RSAs increase 50 basis points and on RSLs increase 60 basis points?
c. What is the impact over the next two years on net interest income if interest rates on RSAs increase 50 basis points and on RSLs increase 75 basis points?
d. Explain the difference in your answers to parts (b) and (c). Why is one answer a negative change in NII, while the other is positive?
12. A bank has the following balance sheet:
Assets Avg. Rate Liabilities/Equity Avg. Rate
Rate sensitive $225,000 6.35% Rate sensitive $300,000 4.25%
Fixed rate 550,000 7.55 Fixed rate 505,000 6.15
Nonearning 120,000 Nonpaying 90,000
Total $895,000 Total $895,000
Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis points.
a. Calculate the bank's repricing GAP.b. Assuming the bank does not change the composition of its balance sheet, calculate the net interest income for the bank before and after the interest rate changes. What is the resulting change in net interest income?
c. Explain how the CGAP and spread effects influenced this increase in net interest income.
13. What are some of the weakness of the repricing model? How have large banks solved the problem of choosing the optimal time period for repricing? What is runoff cash flow, and how does this amount affect the repricing model's analysis?
14. The current one-year Treasury bill rate is 5.2 percent, and the expected one-year rate 12 months from now is 5.8 percent. According to the unbiased expectations theory, what should be the current rate for a two-year Treasury security?
15. Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:
1R1=6%E(2r1)=7% E(3r1)=7.5% E(4r1)=7.85%
Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. Plot the resulting yield curve.
16. The Wall Street Journal reported interest rates of 6 percent, 6.35 percent, 6.65 percent, and 6.75 percent for three-year, four-year, five-year, and six-year Treasury notes, respectively. According to the unbiased expectations theory, what are the expected one-year rates for years 4, 5, and 6?
17. The Wall Street Journal reports that the rate on three-year Treasury securities is 5.60 percent and the rate on four-year Treasury securities is 5.65 percent. According to the unbiased expectations hypothesis, what does the market expect the one-year Treasury rate to be in year 4, E(4r1)?
18.How does the liquidity premium theory of the term structure of interest rates differ from the unbiased expectations theory? In a normal economic environment, that is, an upward- sloping yield curve, what is the relationship of liquidity premiums for successive years into the future? Why?
19.You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning two years from today, 2f1?
Academic requirements:
• Your work must be submitted as pages 8 -10 of pages
• Your work should be submitted in the formats outlined for each questionin the assignment.