UNIVERSITY OF DAR ES SALAAM

BUSINESS SCHOOL
Department of Finance

COURSE FN 307: Treasury Management

Seminar & Review Asset Liability Management (ALM)

Group 4, 5 & 6
1. What factors have motivated banks and many of their competitors to develop Asset Liability
Management techniques in recent years?
2. What is the difference between defensive and aggressive asset/liability management?
What kind of aggressive gap management would be appropriate if interest rates are
expected to fall?
3. Distinguish between the incremental gap and the cumulative gap. Why is this distinction
important?
4. Explain the concept of weighted (Standardized) interest-sensitive gap. How can this
concept aid management in measuring a financial institution’s real interest-sensitive gap
risk exposure?
5. If a bank has a positive duration gap and interest rates risk, what will happen to bank equity?
Explain your answer.
6. How does a policy of matching the maturities of assets and liabilities work;
a. to minimize interest rate risk and
b. against the asset-transformation function for FIs?
7. What are the advantages of using duration as an asset-liability management tool as
opposed to interest-sensitive gap analysis?
8. Consider the following balance sheet for WatchoverU Savings, Inc. (in millions):

ASSETS LIABILITIES & EQUITY

Floating-rate mortgages TZS 50 1-year time deposits TZS 70
(Currently 10% Annually) (Currently 6% Annually)
30-year fixed-rate loans TZS 50 3-year time deposits TZS 20
(Currently 7% Annually) (Currently 7% Annually)

1
 Equity TZS 10
Total Assets TZS 100 Total Liabilities & Equity TZS 100
a. What is WatchoverU’s expected net interest income at year-end?
b. What will net interest income be at year-end if interest rates rise by 2 percent?
c. Using the cumulative repricing gap model, what is the expected net interest
income for a 2 percent increase in interest rates?
d. What will net interest income be at year-end if interest rates on RSAs increase by
2 percent but interest rates on RSLs increase by 1 percent? Is it reasonable for
changes in interest rates on RSAs and RSLs to differ? Why?
9. Given the following information:
Assets Million TZS Rate Liabilities & Equity Million TZS Rate
Rate sensitive 3,000 10.0% Rate sensitive 2,000 8.0%
Non rate sensitive 1,500 9.0 Non rate sensitive 2,000 7.0
Nonearning 500 Equity 1,000
5,000 5,000
a. Calculate the expected net interest income at current interest rates and assuming no
change in the composition of the portfolio. What is the net interest margin?
b. Assuming that all interest rates rise by 1 percentage point, calculate the new expected
net interest income and net interest margin.

10. The ALCO has obtained the following information on the interest rate sensitivity of your bank:
Amount Rate
90 day Interest rate Sensitive Assets TZS 80,000 8.0%

90 day Interest Rate Sensitive Liabilities TZS 120,000 6.0%

The consensus of forecasting is for interest rates to increase by 50 basis points during the ninety
days. But a significant minority of forecasters expects rates to fall by 50 basis points.
a. How could the bank eliminate its interest rate risk?

2
 b. What could happen to net interest income if the minority forecast turned out to be the
correct one?
11. Calculate the duration gap of the following bank.
Assets Liabilities/Equity
Figures in thousands of TZS
Amount % Duration Transaction % Duration
Cash 1000 (years) Deposits 3,000 4.0% 0.5
Securities 2000 4.0% 5.0 CD’s 9,000 6.0% 4.0
Loans l0,000 8.0% 4 Equity 1,000
13,000 13,000

a. Calculate the percentage and dollar change in the value of equity if all interest rates
increase by 200 basis points. How could the bank protect itself from this anticipated
interest rate change?
b. What are the principal limitations of duration gap analysis? Can you think of some
ways of reducing the impact of these limitations?
12. Assume that the ABC National Bank has the following structure of assets and liabilities:
Assets Liabilities
Figures in Thousands TZS
Floating Rate Business Variable Rate Liabilities
250
Loans consisting of Floating
Federal Funds 50 200
Rate CD, and Money
Market Deposit Accounts
Fixed Rate Loans and
700 Federal funds Purchased 200
investments
Fixed Rate Liabilities 500
Equity 100
Total
Total Assets 1,000 1,000
Liabilities and Equity

a. What is the dollar or maturity gap of the bank?

b. Assuming that floating rate business loans are 20 percent as volatile as treasury
bills, that federal funds are 200 percent as volatile as treasury bills, and that

3
 variable rate liabilities other than federal funds purchased are 10 percent as
volatile as treasury bills, what is the standardized gap?
c. Does the standardized gap suggest a different conclusion about interest rate risk?
13. As a management trainee assigned to the bank’s Asset/Liability Management committee, you
have been asked to calculate the duration of each of the following loans:
a. TZS20,000,000 principal, TZS4,500,000 payments per year for five years.
b. TZS20,000,000 principal, TZS4,200,000 payments per year for five years
Assume that the bank’s current required return on these types of loans is 8%.
14. Two banks are being examined by regulators to determine the interest rate sensitivity of
their balance sheets. Bank A has assets composed solely of a 10-year TZS1 million loan
with a coupon rate and yield of 12 percent. The loan is financed with a 10-year TZS1
million CD with a coupon rate and yield of 10 percent. Bank B has assets composed solely
of a 7-year, 12 percent zero-coupon bond with a current (market) value of TZS894,006.20
and a maturity (principal) value of TZS1,976,362.88. The bond is financed with a 10-
year, 8.275 percent coupon TZS1,000,000 face value CD with a yield to maturity of 10
percent. The loan and the CDs pay interest annually, with principal due at maturity.
a. If market interest rates increase 1 percent (100 basis points), how do the market
values of the assets and liabilities of each bank change? That is, what will be the
net effect on the market value of the equity for each bank?
b. What accounts for the differences in the changes in the market value of equity
between the two banks?
c. Verify your results above by calculating the duration for the assets and liabilities
of each bank and estimate the changes in value for the expected change in interest
rates. Summarize your results.