PROBLEMS RELATED TO INTEREST RATE RISK

1) Use the following information about a hypothetical government security dealer named M.P.
Jorgan. Market yields are in parenthesis, and amounts are in millions.
Assets
Cash
1-month T-bills (7.05%)
3-month T-bills (7.25%)
2-year T-notes (7.50%)
8-year T-notes (8.96%)
5-year munis (floating rate)
(8.20% reset every 6 months)
Total assets

$10
75
75
50
100
25
$335

Liabilities and Equity

Overnight repos
Subordinated debt
7-year fixed rate (8.55%)

Equity
Total liabilities & equity

$170
150

15
$335

a. What is the repricing gap if the planning period is 30 days? 3 months? 2 years?
Recall that cash is a non-interest-earning asset.
b.
What is the impact over the next 30 days on net interest income if interest rates
increase 50 basis points? Decrease 75 basis points?
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?
d. If runoffs are considered, what is the effect on net interest income at year-end if
interest rates increase 50 basis points? Decrease 75 basis points?
2) A bank has the following balance sheet:
Assets
Rate sensitive
Fixed rate
Nonearning
Total

$550,000
755,000
265,000
$1,570,000

Avg. Rate
7.75%
8.75

Liabilities/Equity
Rate sensitive $375,000
Fixed rate
Nonpaying
Total

805,000
390,000
$1,570,000

Avg. Rate
6.25%
7.50

Suppose interest rates rise such that the average yield on rate-sensitive assets increases
by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis
points.
a. Calculate the banks repricing GAP and gap ratio.
b. Assuming the bank does not change the composition of its balance sheet, calculate
the resulting change in the banks interest income, interest expense, and net interest
income.
c. Explain how the CGAP and spread effects influenced the change in net interest
income.

3)

A bank has the following balance sheet:

Assets
Rate sensitive
Fixed rate
Nonearning
Total

$550,000
755,000
265,000
$1,570,000

Avg. Rate
7.75%

Liabilities/Equity
Rate sensitive $575,000

8.75

Fixed rate
Nonpaying
Total

Avg. Rate
6.25%

605,000
390,000
$1,570,000

7.50

Suppose interest rates fall such that the average yield on rate-sensitive assets decreases
by 15 basis points and the average yield on rate-sensitive liabilities decreases by 5 basis
points.
a. Calculate the banks CGAP and gap ratio.
b. Assuming the bank does not change the composition of its balance sheet, calculate
the resulting change in the banks interest income, interest expense, and net interest
income.
c. The banks CGAP is negative and interest rates decreased, yet net interest income
decreased. Explain how the CGAP and spread effects influenced this decrease in net
interest income.
4) County Bank has the following market value balance sheet (in millions, all interest at
annual rates). All securities are selling at par equal to book value.
Assets
Cash
$20
15-year commercial loan at 10%
interest, balloon payment
160
30-year mortgages at 8% interest,
balloon payment
300
Total assets

$480

Liabilities and Equity

Demand deposits
5-year CDs at 6% interest,
balloon payment
20-year debentures at 7% interest,
balloon payment
Equity
Total liabilities & equity

$100
210
120
50
$480

a. What is the maturity gap for County Bank?

b. What will be the maturity gap if the interest rates on all assets and liabilities increase
by 1 percent?
c. What will happen to the market value of the equity?
5)

Gunnison Insurance has reported the following balance sheet (in thousands):
Assets
2-year Treasury note
15-year munis

$175
165

Liabilities and Equity

1-year commercial paper
5-year note
Equity

$135
160
45

Total assets

$340

Total liabilities & equity

$340

All securities are selling at par equal to book value. The two-year notes are yielding 5
percent, and the 15-year munis are yielding 9 percent. The one-year commercial paper
pays 4.5 percent, and the five-year notes pay 8 percent. All instruments pay interest
annually.
a. What is the weighted-average maturity of the assets for Gunnison?
b. What is the weighted-average maturity of the liabilities for Gunnison?
c. What is the maturity gap for Gunnison?
d. What does your answer to part (c) imply about the interest rate exposure of
Gunnison Insurance?
e. Calculate the values of all four securities of Gunnison Insurances balance sheet
assuming that all interest rates increase 2 percent. What is the dollar change in the
total asset and total liability values? What is the percentage change in these values?
f. What is the dollar impact on the market value of equity for Gunnison? What is the
percentage change in the value of the equity?
g. What would be the impact on Gunnisons market value of equity if the liabilities
paid interest semiannually instead of annually?
6) Financial Institution XY has assets of $1 million invested in a 30-year, 10 percent
semiannual coupon Treasury bond selling at par. The duration of this bond has been
estimated at 9.94 years. The assets are financed with equity and a $900,000, two-year, 7.25
percent semiannual coupon capital note selling at par.
a. What is the leverage adjusted duration gap of Financial Institution XY?
b. What is the impact on equity value if the relative change in all market interest rates
is a decrease of 20 basis points? Note: The relative change in interest rates is R/
(1+R/2) = -0.0020.
c. Using the information calculated in parts (a) and (b), what can be said about the
desired duration gap for a financial institution if interest rates are expected to
increase or decrease.

d. Verify your answer to part (c) by calculating the change in the market value of
equity assuming that the relative change in all market interest rates is an increase of
30 basis points.
e. What would the duration of the assets need to be to immunize the equity from
changes in market interest rates?
7) The balance sheet for Gotbucks Bank, Inc. (GBI), is presented below ($ millions):
Assets
Cash
Federal funds
Loans (floating)
Loans (fixed)
Total assets

$30
20
105
65
$220

Liabilities and Equity

Core deposits
Federal funds
Euro CDs
Equity
Total liabilities & equity

$20
50
130
20
$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. Euros 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 GBIs assets?
c. What is the duration of the core deposits if they are priced at par?
d. If the duration of the Euro CDs and fed funds liabilities is 0.401 year, what is the
duration of GBIs liabilities?
e. What is GBIs duration gap? What is its interest rate risk exposure?
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?