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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

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

= $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

$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

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

= $110

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

$617.5 $273

$344.5

a.)

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

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

b.)

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.

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