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Question: On p. 250 in the textbook, Problem 11-12, Snowman Bank, N.…

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On p. 250 in the textbook, Problem 11-12, Snowman Bank, N.A. has a portfolio of loans and securities that is expected to
generate cash inflows for the bank. Include a spreadsheet to show your calculations. In addition, answer the following 17 questions remaining
questions in your paper:

What is the duration of Snowman’s portfolio of earned assets, and of its deposits and money market borrowings?
What will happen to the bank’s total returns, assuming all other factors are held constant, if interest rates rise? If interest rate Snap a photo from your
fall? phone to post a question
Given the size of the duration gap you have calculated, in what type of hedging should Snowman engage?
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If the bank has total assets of $20 billion and total liabilities of $18 billion, by how much would the value of Snowman’s net
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worth change as a result of this movement in interest rates?
Suppose, on the other hand, that interest rates decline from 4.25% to 3.5%. What happens to the value of Snowman’s net
worth in this case, and by how much in dollars does it change? 888-888-8888 Text me
What is the size of its duration gap?

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Question 11:

Part a)

The duration of earning assets and deposits and money market borrowings is determined as below:

Duration of Earning Assets = [(1,275,600*1)/(1+4.25%)^1 + (746,872*2)/(1+4.25%)^2 +

(341,555*3)/(1+4.25%)^3 + (62,482*4)/(1+4.25%)^4 + (9,871*5)/(1+4.25%)^5]/[(1,275,600)/(1+4.25%)^1 +
(746,872)/(1+4.25%)^2 + (341,555)/(1+4.25%)^3 + (62,482)/(1+4.25%)^4 + (9,871)/(1+4.25%)^5] =
3,754,097/2,273,192 = 1.6515 Years

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On P. 250 In The Textbook, Problem 11-12, Snowman ... | Chegg.com 23/11/21, 10:46 AM

Duration of Deposits and Money Market Borrowings = [(1,295,500*1)/(1+4.25%)^1 +

(831,454*2)/(1+4.25%)^2 + (123,897*3)/(1+4.25%)^3 + (1,005*4)/(1+4.25%)^4/[(1,295,500)/(1+4.25%)^1 +
(831,454)/(1+4.25%)^2 + (123,897)/(1+4.25%)^3 + (1,005)/(1+4.25%)^4] = 3,104,237/2,117,934 = 1.4657 Years

Duration Gap = Duration of Earning Assets - Duration of Deposits and Money Market Borrowings = 1.6515
- 1.4657 = .1858 years

_____

Part b)

Impact of Interest Rate on Total Returns

Based on the calculations in Part A, it can be concluded that the bank has a positive duration gap (as the
duration of its assets exceeds the duration of its liabilities). As a result, an increase in interest rate would
cause a decline in the total returns/net worth of the bank. It is because the fall in the value of the liabilities
(as a result of increase in interest rates) will be less than the decline in the value of bank's assets, that is, the
bank's assets will decline more in value when compared with the decrease in the value of its liabilities. In
contrast, a decline in interest rates would result in an increase in the total returns/net worth of the bank. It
is because the increase in the value of assets (as a result of fall in interest rates) will be more than the
increase in the value of bank's liabilities.

_____

Part c)

Type of Hedging

The bank should focus on reducing the duration gap by matching the duration of its assets with the
duration of its liabilities. This can be achieved with the help of instruments like futures and options. The
banks can sell some of its assets and invest the cash "ows realized (from such a sale) in assets with
maturities that match the maturities of its liabilities. Another option would be to enter into interest rate
swaps and cause a change to the pattern of cash "ows associated with its liabilities in order to match the
maturities of bank's assets.

_____

Question 12:

Part a)

Change in Net Worth When Interest Rates Increase from 4.25% to 4.75%

The change in net worth as a result of movement in interest rates is calculated as below:

Change in Net Worth = [(-Duration of Assets)*(Change in Interest Rate)/(1+Original Interest Rate)*Total

Assets] - [(-Duration of Liabilities)*(Change in Interest Rate)/(1+Original Interest Rate)*Total Liabilities]

Using the information provided in the question and values calculated in Part a) of Question 11, we get,

Change in Net Worth = [(-1.6515)*(4.75% - 4.25%)/(1+4.25%)*20] - [(-1.4657)*(4.75% - 4.25%)/(1+4.25%)*18]

= -0.0319 billion

_____

Part b)

Change in Net Worth When Interest Rates Decrease from 4.25% to 3.50%

Change in Net Worth = [(-Duration of Assets)*(Change in Interest Rate)/(1+Original Interest Rate)*Total

Assets] - [(-Duration of Liabilities)*(Change in Interest Rate)/(1+Original Interest Rate)*Total Liabilities]

Using the information provided in the question and values calculated in Part a) of Question 11, we get,

Change in Net Worth = [(-1.6515)*(3.50% - 4.25%)/(1+4.25%)*20] - [(-1.4657)*(3.50% - 4.25%)/(1+4.25%)*18]

= 0.0478 billion

_____

Part c)

Duration Gap

The size of duration gap with 20 billion assets and liabilities of 18 billion is arrived as below:

Size of Duration Gap = Duration of Earning Assets - Duration of Deposits and Money Market Borrowings*
(Total Liabilities/Total Assets) = 1.6515 - 1.4657*(18/20) = .3324
"

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On P. 250 In The Textbook, Problem 11-12, Snowman ... | Chegg.com 23/11/21, 10:46 AM

Q: On p. 250 in the textbook, Problem 11-12, Snowman Bank, N.A. has a portfolio of loans and securities that is expected
to generate cash in"ows for the bank. Include a spreadsheet to show your calculations. In addition, answer the
following questions in your paper: What is the duration of Snowman’s portfolio of earned assets, and of its deposits
and money market borrowings? What...

A: See answer

Q: On p. 250 in the textbook, Problem 11-12, Snowman Bank, N.A. has a portfolio of loans and securities that is expected
to generate cash in"ows for the bank. Include a spreadsheet to show your calculations. In addition, answer the
following questions in your paper: What is the duration of Snowman's portfolio of earned assets, and of its deposits
and money market borrowings? What will...

A: See answer

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