Dr.

Le Anh Tuan

Selected Problems for Session 4 – Interest Rate Risk

End-chapter exercises

S4.1
Consider the following balance sheet for MMC Bancorp (in millions of dollars):

Assets Liabilities
1. Cash and due from $ 6.25 1. Equity capital (fixed) $25.00
2. Short-term consumer loans 62.50
(one-year maturity) 2. Demand deposits 50.00
3. Long-term consumer loans 31.25
(two-year maturity) 3. Passbook savings 37.50
4. Three-month T-bills 37.50 4. Three-month CDs 50.00
5. Six-month T-notes 43.75 5. Three-month banker’s
acceptances 25.00
6. Three-year T-bonds 75.00 6. Six-month commercial paper 75.00
7. 10-year, fixed-rate mortgages 25.00 7. One-year time deposits 25.00
8. 30-year, floating-rate
mortgages 50.00 8. Two-year time deposits 50.00
9. Premises 6.25
$337.50 $337.50

a. Calculate the value of MMC’s rate-sensitive assets, rate-sensitive liabilities, and repricing
gap over the next year.
b. Calculate the expected change in the net interest income for the bank if interest rates rise
by 1 percent on both RSAs and RSLs and if interest rates fall by 1 percent on both RSAs
and RSLs.
c. Calculate the expected change in the net interest income for the bank if interest rates rise
by 1.2 percent on RSAs and by 1 percent on RSLs.

S4.2

Consider the following balance sheet for WatchoverU Savings, Inc. (in millions):

Assets Liabilities and Equity

Floating-rate mortgages 1-year time deposits
(currently 10% annually) $50 (currently 6% annually) $70
30-year fixed-rate loans 3-year time deposits
(currently 7% annually) $50 (currently 7% annually) $20
Equity $10
Total assets $100 Total liabilities & equity $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?
 Dr. Le Anh Tuan

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?

S4.3

A one-year, $100,000 loan carries a coupon rate and a market interest rate of 12 percent. The loan
requires payment of accrued interest and one-half of the principal at the end of six months. The
remaining principal and the accrued interest are due at the end of the year.

a. What will be the cash flows at the end of six months and at the end of the year?
b. What is the present value of each cash flow discounted at the market rate? What is the total
present value?
c. What proportion of the total present value of cash flows occurs at the end of six months?
What proportion occurs at the end of the year?
d. What is the duration of this loan?

S4.4

Calculate the duration of a two-year, $1,000 bond that pays an annual coupon of 10 percent and
trades at a yield of 14 percent. What is the expected change in the price of the bond if interest rates
fall by 0.50 percent?

S4.5

The balance sheet for Gotbucks Bank, Inc. (GBI), is presented below ($ millions):

Assets Liabilities and Equity

Cash $30 Core deposits $20
Federal funds 20 Federal funds 50
Loans (floating) 105 Euro CDs 130
Loans (fixed) 65 Equity 20
Total assets $220 Total liabilities & equity $220

Notes to the balance sheet: The fed funds rate is 8.5 percent, the floating loan rate is LIBOR + 4
percent, and currently LIBOR is 11 percent. Fixed rate loans have five-year maturities, are priced
at par, and pay 12 percent annual interest. The principal is repaid at maturity. Core deposits are
fixed rate for two years at 8 percent paid annually. The principal is repaid at maturity. Euro CDs
currently yield 9 percent.

a. What is the duration of the fixed-rate loan portfolio of Gotbucks Bank?

b. If the duration of the floating-rate loans and fed funds is 0.36 year, what is the duration
of GBI’s assets?
c. What is the duration of the core deposits if they are priced at par?
 Dr. Le Anh Tuan

f. What is the impact on the market value of equity if the relative change in all interest rates
is an increase of 1 percent (100 basis points)? Note that the relative change in interest
rates is R/(1+R) = 0.01.
g. What is the impact on the market value of equity if the relative change in all interest rates
is a decrease of 0.5 percent (-50 basis points)?
h. What variables are available to GBI to immunize the bank? How much would each
variable need to change to get DGAP equal to zero?
S4.6

Integrated Mini Case Chapters 8 and 9: Calculating and Using Repricing and Duration GAP

State Bank’s balance sheet is listed below. Market yields and durations (in years) are in
parenthesis, and amounts are in millions.

Assets Liabilities and Equity

Cash $31 Demand deposits $253
Fed funds (2.05%, 0.02) 150 Savings accounts (0.5%, 1.25) 50
3-month T-bills (3.25%, 0.22) 200 MMDAs (3.5%, 0.50)
8-year T-bonds (6.50%, 7.55) 250 (no minimum balance requirement) 460
5-year munis (7.20%, 4.25) 50 3-month CDs (3.2%, 0.20) 175
6-month consumer loans (5%, 0.42) 250 1-year CDs (3.5%, 0.95) 375
5-year car loans (6%, 3.78) 350 5-year CDs (5%, 4.85) 350
7-month C&I loans (4.8%, 0.55) 200 Fed funds (2%, 0.02) 225
2-year C&I loans (4.15%, 1.65) 275 Repos (2%, 0.05) 290
Fixed-rate mortgages (5.10%, 0.48) 6-month commercial paper
(maturing in 5 months) 450 (4.05%, 0.55) 300
Fixed-rate mortgages (6.85%, 0.85) Subordinate notes:
(maturing in 1 year) 300 1-year fixed rate (5.55%, 0.92) 200
Fixed-rate mortgages (5.30%, 4.45) Subordinated debt:
(maturing in 5 years) 275 7-year fixed rate (6.25%, 6.65) 100
Fixed-rate mortgages (5.40%, 18.25) Total liabilities $2,778
(maturing in 20 years) 355
Premises and equipment 20 Equity 3078
Total assets $3,156 Total liabilities and equity $3,156

a. What is the repricing gap if the planning period is six months? One year?
b. What is State Bank’s modified duration gap?
c. What is the impact over the next six months on net interest income if interest rates on
RSAs increase 50 basis points and on RSLs increase 35 basis points? Explain the results.
d. What is the impact over the next year on net interest income if interest rates on RSAs
decrease (increase) 35 basis points and on RSLs decrease (increase) 50 basis points?
Explain the results.
e. What is the change in equity value forecasted from the duration values for decrease of 0.35
percent in interest rates on assets and 0.50 percent on liabilities?
f. Use the duration gap model to calculate the change in equity value if the relative change in
all market interest rates is a decrease of 50 basis points.
 Dr. Le Anh Tuan

Additional exercises

S4.7

Are these banks rate-sensitive assets or rate-sensitive liabilities?

S4.8

Consider the following bank balance sheet (in $million) and associated average interest rates. The
time frame for rate sensitivity is one year. Figures are in thousands.

Assets Amount Rate Liabilities and Equity Amount Rate

Rate sensitive $100 5% Rate sensitive $80 3%
Fixed rate $150 8% Fixed rate $160 4.5%
Nonearning $30 Equity $40
Total $280 $280

a. Calculate the bank’s GAP, expected NII, and NIM if interest rates and portfolio composition
remain constant during the year. This bank is positioned to profit if interest rates move in
which direction? Notes that NIM are calculated by scaling the earnings assets.
b. Calculate the change in expected NII and NIM if the entire yield curve shifts 2 percent higher
during the year. Is this outcome consistent with the bank’s GAP strategy?
c. Suppose that, instead of the parallel shift in the yield curve in Part b, interest rates increase
unevenly. Specifically, suppose that asset yields rise by 0.50 percent while liability rates rise
by 1 percent. Calculate the change in NII and NIM.
d. Assume that the amounts of runoff occur within a year is $15 for rate sensitive liabilities and
$ 10 for rate sensitive assets. Adjusting for runoff, what is the annualized change in the
bank’s future net interest income if the interest rates increase by 1% on average?