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# 7-4. 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 banks interest revenues rise by
5 percent and its interest costs and earnings assets increase by 9 percent. What will happen to
Farmvilles net interest margin?
The relevant formula is:
\$95 mill. \$82 mill.
Total earning assets
Net interest margin = 0.0275 =
Then, total earning assets must be \$473 million.
If revenues rise by 5 percent, and interest costs and earnings assets rise by 9 percent, net interest
margin is:
\$95(1.05) \$82(1.09)
473(1.09)
Net interest margin =

99.75 89.38
515.57

## = 0.0201 or 2.01 percent

7-5. If a credit unions net interest margin, which was 2.50 percent, increases 10 percent and
its total assets, which stood originally at \$575 million, rise by 20 percent, what change will occur
in the bank's net interest income?
The correct formula is:
Net interest income
Net interest margin
Total earning assets
Original net interest income = Net interest margin Total earning assets
= 2.5% \$575 million = \$14.375 million
New net interest income:
0.025 1.10

\$575 million1.20

## Net Interest Income = 0.0275 690

= \$18.975 million
Change in net interest income = New net interest income Original net interest income
= \$18.975 million - \$14.375 million = \$4.6 million.
7-6. The cumulative interest rate gap of Poquoson Savings Bank increases 60 percent from an
initial figure of \$25 million. If market interest rates rise by 25 percent from an initial level of 3
percent, what changes will occur in this thrifts net interest income?
New net interest income = New market interest rate Increase in assets
= 3.75 percent \$40 million = \$1.5 million
Initial net interest income = Initial market interest rate Initial assets
= 3 percent \$25 million = \$0.75 million
Percent change in net interest income = (\$1.5 million \$0.75 million)/ \$0.75 million
= 100 percent
Thus, the bank's net interest income will increase by 100 percent.
7-7. New Comers State Bank has recorded the following financial data for the past three years
(dollars in millions):
Interest revenues
Interest expenses
Loans (excluding nonperforming)
Investments
Total deposits
Money market borrowings

Current Year
\$82
64
450
200
450
150

Previous Year
\$80
66
425
195
425
125

## Two Years Ago

\$78
68
400
200
400
100

What has been happening to the banks net interest margin? What do you think caused the
changes you have observed? Do you have any recommendations for New Comers management
team?
Net interest margin (NIM) = Net interest income/Total earning assets
Where,
Net interest income = Net interest revenues - Net interest expenses
Total earning assets = Loans + Investments
NIM (Current) = (\$82-64)/ (450 + 200) = 18/650 = 0.028 or 2.77%
NIM (Previous) = (\$80-66)/ (425 + 195) = 14/620 = 0.0226 or 2.26%
NIM (Two years ago) = (\$78-68)/ (400 + 200) = 10/600 = 0.0167 or 1.67%

The net interest margin has been increasing over the years. As interest revenues and expenses as
well as the banks assets have increased consistently over the years, there has been a constant
increase in the net interest margin. If the bank can further cut down on its interest expenses and
increase its assets in the next years, the net interest margin will increase at a higher rate.
7-8
The First National Bank of Dogsville finds that its asset and liability portfolio contains
the following distribution of maturities and repricing opportunities:

Loans
Securities
Interest-sensitive assets
Transaction deposits
Time accts.
Money market borrowings
Interest-sensitive liabilities

Coming
Week
\$200.00
21.00

Next 30
Days
\$300.00
26.00

Next 31-90
Days
\$475.00
40.00

More Than
90 Days
\$525.00
70.00

\$320.00
100.00
136.00

\$ 0.00
290.00
140.00

\$ 0.00
196.00
100.00

\$ 0.00
100.00
65.00

When and by how much is the bank exposed to interest rate risk? For each maturity or repricing
interval, what changes in interest rates will be beneficial and which will be damaging, given the
current portfolio position?
Coming
Week
\$200
21
\$221

Next 30
Days
\$300
26
\$326

Next 31-90
Days
\$475
40
\$515

More Than 90
Days
\$525
70
\$595

Transaction
deposits
Time Accts.
Money Mkt. Borr.
Total IS Liab.

\$320

100
136
\$556

290
140
\$430

196
100
\$296

100
65
\$165

GAP

335

104

+219

+430

Cumulative GAP

335

439

220

+210

Loans
Securities
Total IS Assets

First National has a negative gap in the nearest period and therefore would benefit if interest
rates fall. In the next period it has a slightly negative gap and would therefore benefit of interest
rate rise. However, its cumulative gap is still negative. The third period is positive gap and hence
the bank would benefit if interest rates rise. In the final period the gap is positive and the bank
would benefit if interest rates rise. Its cumulative gap is slightly positive and also shows that
rising interest rates would be beneficial to the bank overall.

7-9
Sunset Savings Bank currently has the following interest-sensitive assets and liabilities
on its balance sheet with the interest-rate sensitivity weights noted.
Interest-Sensitive Assets
Federal fund loans
Security holdings
Loans and leases
Interest-Sensitive Liabilities
Interest-bearing deposits
Money-market borrowings

\$ Amount
\$ 50.00
50.00
350.00
\$ Amount
\$ 250.00
90.00

## Rate Sensitivity Index

1.00
1.20
1.45
Rate Sensitivity Index
0.75
0.95

What is the banks current interest-sensitive gap? Adjusting for these various interest rate
sensitivity weights what is the banks weighted interest-sensitive gap? Suppose the federal funds
interest rate increases or decreases 50 basis points. How will the banks net interest income be
affected (a) given its current balance sheet makeup and (b) reflecting its weighted balance sheet
adjusted for the foregoing rate-sensitivity indexes?
Dollar IS Gap

## = ISA - ISL = (\$50 + \$50 + \$350) (\$250 + \$90)

= \$110

Weighted IS Gap 1 \$50 1.20 50 1.45 350 0.75 \$250 0.95 \$90

\$617.5 \$273
\$344.5

a.)

## Change in Banks Income = IS Gap Change in interest rates

= (\$110) (0.005) = \$0.55 million

Using the regular IS Gap; net income will change by plus or minus \$550,000
b.)

## = (\$344.50) (0.005) = \$1.72250

Using the weighted IS Gap; net income will change by plus or minus \$1,722,500.
7-10 Sparkle Savings Association has interest-sensitive assets of \$400 million, interestsensitive liabilities of \$325 million, and total assets of \$500 million. What is the banks dollar
interest-sensitive gap? What is Sparkles relative interest-sensitive gap? What is the value of its
interest-sensitivity ratio? Is it asset sensitive or liability sensitive? Under what scenario for
market interest rates will Sparkle experience a gain in net interest income? A loss in net interest
income?
Dollar Interest-Sensitive Gap = ISA ISL = \$400 million \$325 million = \$75 million

Relative IS Gap
Interest-Sensitivity Ratio

=
=

ISA
ISL

ISA ISL
Bank Size
=

\$400
\$325

\$75
\$500

= 0.15

= 1.23

Here, the interest sensitivity gap is positive and asset sensitive as the interest sensitive assets are
greater than interest sensitive liabilities. Sparkle Savings Association, being an asset sensitive
financial firm, will have a positive relative IS gap and an interest-sensitivity ratio greater than 1.
In case of a positive IS gap, there will be a gain in net interest income if the market interest rates
are rising. For a positive IS gap, there will be a loss in net interest income, if the market interest
rates are falling.