1、1. What is the process of asset transformation performed by a financial institution? Why does this process often lead to the creation of interest rate risk ? What is interest rate risk?Asset transformation by an FI involves purchasing primary assets and issuing secondaryassets as a source of funds.

2、The primary securities purchased by the FI often have maturity and liquidity characteristics that are different from the secondary securities issued by the FI. For example, a bank buys medium- to long-term bonds and makes medium-term l oans with funds raised by issuing short-term deposits.Interest r

3、ate risk occurs because the prices and reinvestment income characteristics of long-term assets react differently to changes in market interest rates than the prices and interest expense characteristics of short-term deposits. Interest rate risk is the risk incurred by an FI when the maturities of it

4、s assets and liabilities are mismatched.2. The sales literature of a mutual fund claims that the fund has no risk exposure since it invests exclusively in federal government securities that are free of default risk. Is this claim true? Explain why or why not.Although the fund's asset portfolio i

5、s comprised of securities with no default risk, the securities are exposed to interest rate risk. For example, if interest rates increase, the market value of the fund's Treasury security portfolio will decrease. Further, if interest rates decrease, the realized yield on these securities will be

6、 less than the expected rate of return because of reinvestment risk. In either case, investors who liquidate their positions in the fund may sell at a Net Asset Value (NAV) that is lower than the purchase price.3. What is market risk? How do the results of this risk surface in the operating performa

7、nce of financial institutions? What actions can be taken by FI management to minimize the effects of this risk?Market risk is the risk incurred from assets and liabilities in an FI s trading bochanges in interest rates, exchange rates, and other prices. Market risk affects any firm that trades asset

8、s and liabilities. The risk can surface because of changes in interest rates, exchange rates, or any other prices of financial assets that are traded rather than held on the balance sheet. Market risk can be minimized by using appropriate hedging techniques such as futures, options, and swaps, and b

9、y implementing controls that limit the amount of exposure taken by market makers.4. What is credit risk ? Which types of FIs are more susceptibl e to this type of risk? Why?Credit risk is the risk that promised cash flows from loans and securities held by FIs may not be paid in full. FIs that lend m

10、oney for long periods of time, whether as loans or by buying bonds, are more susceptible to this risk than those FIs that have short investment horizons. For example, life insurance companies and depository institutions generally must wait a longer time for returns to be realized than money market m

11、utual funds and property-casualty insurance companies.5. What is foreign exchange risk ? What does it mean for an FI to be net long in foreign assets? What d oes it mean for an FI to be net short in foreign assets? In each case, what must happen to the foreign exchange rate to cause the FI to suffer

12、 losses?Foreign exchange risk is the risk that exchange rate changes can affect the value of an FI assets and liabilities denominated in non-domestic currencies. An FI is net long inforeign assets when the foreign currency-denominated assets exceed the foreign currency denominated liabilities. In th

13、is case, an FI will suffer potential losses if the domestic currency strengthens relative to the foreign currency when repayment of the assets will occur in the foreign currency. An FI is net short in foreign assets when the foreign currency-denominated liabilities exceed the foreign currency denomi

14、nated assets. In this case, an FI will suffer potential losses if the domestic currency weakens relative to the foreign currency when repayment of the liabilities will occur in the domestic currency.6. What is the repricing gap? In using this model to evaluate interest rate risk, what is meant by ra

15、te sensitivity? On what financial performance variable does the repricing model focus? Explain.The repricing gap is a measure of the difference between the dollar value of assets that will reprice and the dollar value of liabilities that will reprice within a specific time period, where reprice mean

16、s the potential to receive a new interest rate Rate sensitivity represents the time interval where repricing can occur. The model focuses on the potential changes in the net interest income variable.In effect, if interest rates change, interest income and interest expense will change as the various

17、assets and liabilities are repriced, that is, receive new interest rates.7. Use the following information about a hypothetical government security dealer named M.P . Jorgan. Market yields are in parenthesis, and amounts are in millions. 8.11AssetsLiabilities and EquityCash$10Overnight Repos$1701 mon

18、th T-bills (7.05%)75Subordinated debt3 month T-bills (7.25%)757-year fixed rate (8.55%1502 year T-notes (7.50%)508 year T-notes (8.96%)1005 year munis (floating rate)(8.20% reset every 6 months)_25Equity_15Total Assets$335Total Liabilities & Equity$335a. What is the funding or repricing gap if t

19、he planning period is 30 days? 91 days?2 years? Recall that cash is a noninterest-earning asset.Funding or repricing gap using a 30-day planning period = 75 - 170 = -$95 million.Funding gap using a 91-day planning period = (75 + 75) - 170 = -$20 million.Funding gap using a two-year planning period =

20、 (75 + 75 + 50 + 25) - 170 = +$55 million.b. What is the impact over the next 30 days on net interest income if all interest rates rise 50 basis points? Decrease 75 basis points?Net interest income will decline by $475,000. - NII = FG( R) = -95(.005)= $0.475m.Net interest income will increase by $71

21、2,500.- NII = FG( R) = -95(.0075)= $0.7125m.c. The following one-year runoffs are expected: $10 million for two-year T-notes, and $20 million for eight-year T-notes. What is the one-year repricing gap?Funding or repricing gap over the 1-year planning period = (75 + 75 + 10 + 20 + 25)- 170 = +$35 mil

22、lion.d. If runoffs are considered, what is the effect on net interest income at year-end if interest rates rise 50 basis points? Decrease 75 basis points?Net interest income will increase by $175,000. NII = FG( R) = 35(0.005)= $0.175m.Net interest income will decrease by $262,500/ NII = FG( R) = 35(

23、-0.0075)= -$0.2625m.8. Consumer Bank has $20 million in cash and a $180 million loan portfolio. The assets are funded with demand deposits of $18 million, a $162 million CD and $20 million in equity. The loan portfolio has a maturity of 2 years, earns interest at the annual rate of 7 percent, and is

24、 amortized monthly. The bank pays 7 percent annual interest on the CD, but the interest will not be paid until the CD matures at the end of 2 years.a. What is the maturity gap for Consumer Bank?Ma = 0*$20 + 2*$180/$200 = 1.80 yearsMl = 0*$18 + 2*$162/$180 = 1.80 yearsMGAP = 1.80 - 1.80 = 0 years.b.

25、Is Consumer Bank immunized or protected against changes in interest rates? Why or why not?It is tempting to conclude that the bank is immunized because the maturity gap is zero. However, the cash flow stream for the loan and the cash flow stream for the CD are different because the loan amortizes mo

26、nthly and the CD pays annual interest on the CD. Thus any change in interest rates will affect the earning power of the loan more than the interest cost of the CD.c. Does Consumer Bank face interest rate risk? That is, if market interest rates increase or decrease 1 percent, what happens to the valu

27、e of the equity?The bank does face interest rate risk. If market rates increase 1 percent, the value of the cash and demand deposits does not changeHowever, the value of the loan will decrease to $178.19, and the value of the CD will fall to $159.01. Thus the value of the equity will be ($178.19 + $

28、20 - $18 - $159.01) = $21.18. In this case the increase in interest rates causes the market value of equity to increase because of the reinvestment opportunities on the loan payments.If market rates decrease 1 percent, the value of the loan increases to $181.84, and the value of the CD increases to

29、$165.07. Thus the value of the equity decreases to $18.77.d. How can a decrease in interest rates create interest rate risk?The amortized loan payments would be reinvested at lower rates. Thus even though interest rates have decreased, the different cash flow patterns of the loan and the CD have cau

30、sed interest rate risk.79. You have discovered that the price of a bond rose from $975 to $995 when the YTM fell from 9.75 percent to 9.25 percent. What is the duration of the bond?We knowR(1 R)20975-.0051.0975-4.5 years = D =4.5 years10. If you use only duration to immunize your portfolio, what thr

31、ee factors affect changes in the net worth of a financial institution when interest rates change?The change in net worth for a given change in interest rates is given by the following equation:Thus, three factors are important in determining -E.1) Da - D l k or the leveraged adjusted duration gap. T

32、he larger this gap, the more exposed is the FI to changes in interest rates.2) A, or the size of the FI. The larger isA, the larger is the exposure to interest rate changes.3) AR/1 + R, or interest rate shocks. The larger is the shock, the larger is the interest rate risk exposure.11. What is meant

33、by daily earnings at risk (DEAF)? What are the three measurable components? What is the price volatility component?DEAR or Daily Earnings at Risk is defined as the estimated potential loss of a portfolio's value over a one-day unwind period as a result of adverse moves in market conditions, such

34、 as changes in interest rates, foreign exchange rates, and market volatility. DEAR is comprised of (a) the dollar value of the position, (b) the price sensitivity of the assets to changes in the risk factor, and (c) the adverse move in the yield. The product of the price sensitivity of the asset and

35、 the adverse move in the yield provides the price volatility component.12. Bank Two has a portfolio of bonds with a market value of $200 million. The bonds have an estimated price volatility of 0.95 percent. What are the DEAR and the 10-day VAR for these bonds?Daily earnings at risk (DEAR) = ($ Valu

36、e of position) x (Price volatility) =$200 million x .0095 =$1.9million, or $1,900,000Value at risk (VAR)= DEAR x N = $1,900,000 x 10=$1,900,000 x 3.1623 = $6,008,327.5513. The following are the foreign currency positions of an FI, expressed in dollars.15.5CurrencyAssetsLiabilitiesFX BoughtFX SoldSwi

37、ss franc (SF)$125,000$50,000$10,000$15,000British pound (£)50,00022,00015,00020,000Japanese yen (¥)75,00030,00012,00088,000a. What is the FI ' s net exposure in Swiss francs?Net exposure in Swiss francs = $70,000.b. What is the FI ' s net exposBreish pounds?Net exposure in British

38、pounds = $23,000.c. What is the FI ' s net exposure in Japanese yen?Net exposure in Japanese yen = -$31,000d. What is the expected loss or gain if the SF exchange rate appreciates by 1 percent?If assets are greater than liabilities, then an appreciation of the foreign exchange rates will generat

39、e a gain = $70,000 x 0.01 = $7,000.e. What is the expected loss or gain if the exchange rate appreciates by 1 percent?Gain = $23,000 x 0.01 = $230f. What is the expected loss or gain if the exchange rate appreciates by 2 percent?Loss = -$31,000 x 0.02 = -$6,200練習1：Calculate the repricing gap and the

40、 impact on net interest income of a 1 percent increase in interest rates for each of the following positions:Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million.Repricing gap = RSA RSL = $200 $100 million = +$100 million.Nik ($100 million(k01)=+$L0 million, or $1,000,000+

41、Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million.Repricing gap = RSA RSL = $100 $150 million = -$50 million.NII ;(-$50 million)(.01) = -$0.5 million, or -$500,000.Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million.Repricing gap = RSA RSL =

42、$150 $140 million = +$10 million.NII = ($10 million)(,01) = +$0,1 million, or $100,000.練習2:Which of the following assets or liabilities fit the one-year rate or repricing sensitivity test?91-day U.S. Treasury bills Yes1-year U.S. Treasury notes Yes20-year U.S. Treasury bonds No20-year floating-rate

43、corporate bonds with annual repricing Yes30-year floating-rate mortgages with repricing every two years No30-year floating-rate mortgages with repricing every six months YesOvernight fed funds Yes9-month fixed rate CDs Yes 1-year fixed-rate CDs Yes5-year floating-rate CDs with annual repricing YesCo

44、mmon stock No練習3:Consider the following balance sheet for WatchoverU Savings, Inc. (in millions):AssetsLiabilities and EquityFloating-rate mortgagesDemand deposits(currently 10% annually) $50(currently 6% annually) $7030-year fixed-rate loansTime deposits(currently 7% annually)$50(currently 6% annua

45、lly $20Equity$10Total Assets$100Total Liabilities & Equity$100a. What is WatchoverU ' s expected net interest income a-eyear Current expected interest income: $5m + $3.5m = $8.5m.Expected interest expense:$4.2m+$1.2m= $5.4m.Expected net interest income:$8.5m-$5.4m= $3.1m.b. What will be the

46、net interest income at year-end if interest rates rise by 2 percent?After the 200 basis point interest rate increase, net interest income declines to: 50(0.12) + 50(0.07) - 70(0.08) - 20(.06) = $9.5m - $6.8m = $2.7m, a decline of $0.4m.c. Using the cumulative repricing gap model, what is the expecte

47、d net interest income for a 2 percent increase in interest rates?Wachovia' s' repricing or funding gap is $50-r$70m = -$20m. The change in net interest income using the funding gap model is (-$20m)(0.02) = -$.4m.練習4:Ma = 0*20 + 5*60 + 200*30/320 = 19.69 years, and Ml = 0*140 + 1*160/300 = 0.

48、533. Therefore the maturity gap = MGAP = 19.69 -0.533 = 19.16 years.Nearby bank is exposed to an increase in interest rates .If rates rise, the value of assets will decrease much more than the value of liabilities.練習5Ma = 0*20 + 15*160 + 30*300/480 = 23.75 years.Ml = 0*100 + 5*210 + 20*120/430 = 8.0

49、2 years.MGAP = 23.75 -8.02 = 15.73 years.Five-year BondPar value = $1,000 Coupon rate = 15% Annual paymentsR = 9%Maturity = 5 years$137.62$252.50$347.48$425.06Time Cash Flow PV of CF PV of CF x t1$150$137.622$150$126.253$150$115.834$150$106.265$1,150$747.42$3,737.10$1,233.38練習$4,899.76 Duration = $4899.76/1,233.38 =3.97 : 4 yearsThe duration of the capital note is 1.8975 years.Two-year Capital Note (values in thousands of $s)Par value