1. The following financial statement is for the current year.

From the past, you know that 15% of fixed-rate mortgages prepay each year. You also estimate that 10% of deposits and 25% of savings accounts are rate-sensitive First National Bank
Reserves Securities 1 year 1 to 2 years 2 years $3,000,000 0.00 Checkable deposits $15,000,000 Money Market deposits $5,000,000 $15,000,000 2.00 0.10 1.00

$5,000,000 0.40 $6,000,000 1.60 Savings Accounts $12,000,000 7.00 CDs Residential mortgages Variable-rate Variable-rate $12,000,000 0.50 1 year 0.20 Fixed-rate $10,000,000 6.00 1 to 2 year Commercial loans 2 years 1 year $15,000,000 0.70 Interbank loans 1 to 2 years $10,000,000 1.40 Borrowings 2 year $25,000,000 4.00 1 year Buildings, etc. $6,000,000 0.00 1 to year 2 years Bank Capital Total $104,000,000 Total

$10,000,000 0.50 $15,000,000 $6,000,000 $5,000,000 $7,000,000 $10,000,000 $5,000,000 $5,000,000 $6,000,000 $104,000,000 1.20 2.70 0.00 0.30 1.30 3.10

What is the current income gap for first National Bank? What will happen to the banks current net interest income if rates fall by 65 basis points? Increase by 50 basis points. For the next 4 problems assume that the First National Bank initially has the balance sheet that interest rates are initially at 10%. a. If the first National Bank Sells $15 million of its securities with maturities greater than three year and replaces them with securities maturing in less than one year, what is the income gap for the bank? What will happen to profits next year if interest rates fall by 3.5 percentage points? b. If the First National Bank decides to convert $8 million of its fixed-rate mortgages into variable-rate mortgages, what happens to its interest-rate risk? Explain with gap analysis. c. If the manager of the First National Bank revises the estimate of the percentage of fixed-rate mortgages that are repaid within a year from 15% to 10%, what will be the revised estimate of the interest-rate risk the bank faces? What will happen to profits next year if interest rates fall by 2.5 percentage points?

d. If the manager of the First National Bank revises the estimate of the percentage of checkable deposits that are rate-sensitive from 10% to 15%, what will be the revised estimate of the interest rate risk the bank faces? What will happen to profits next year if interest rates rise by 6 percentage points? 2. Hands Insurance Co. issued a $70 million, one year zero coupon note at 8%
add-on annual interest (paying one coupon at the end of the year). The proceeds were used to fund a $100 million, two year commercial loan at 10% annual interest. Immediately after these transactions were simultaneously closed, all market interest rates increased 1.5%. a. What is the true market value of the loan investment and the liability after change in interest rates?

b. What impact did these changes in market value have on the market value of FIs equity? c. What was the duration of the loan investment and the liability at the time of issuance?

d. Use these duration values to calculate the expected change in value of the loan and the liability for the predicted increase of 1.5% in interest rates. 3. MLK bond has an asset portfolio that consists of 25-year, 10% Coupon Rs 3500 bonds that sell at par. (a) What will be the bonds new prices if market yields change immediately by +/- 0.20 Percent +/- 3.5 Percent (b) Calculate the duration of these bonds. What are the predicted bond prices in each of the four cases using duration rules? What is the error between duration prediction and actual market prices? (C ) Given that convexity is 212.4, what are the bond prediction in each of the four cases using duration plus convexity relationship? What is the amount of errors in these predictions? 4. The following information is available for a Financial Institution (T-bonds, 6% semi annually, 5 year maturity) Amount Duration

T Bills T-Notes T-Bonds Loans Deposits Federal Funds Equity

90 55 176 2734 2092 258 715

.6 .9 x 7 1 .01

What is the Duration of the T-Bond Portfolio? What is the average duration of all the assets and liabilities? What is the leverage adjusted duration gap?

5. Axis Bank has the following assets: Assets T-bills Consumer loans Commercial loans Value $160,000,000 $50,000,000 $18,000,000 Duration 0.75 3.45 6.80

What is Axis Banks asset portfolio duration?

6. A bank added a bond to its portfolio. The bond has duration of 15.5 years and cost Rs32080. Just after buying the bond, the bank discovered that market interest rates are expected to rise from 9% to 9.70%. What is the expected change in the bonds value? 7. Calculate the change in the market value of assets and liabilities when the average duration of assets is 4.50, the average duration of liabilities 1.28, and interest rates increase from 6% to 6.85%. 8. A country bank has assets totaling $280 million with duration of five years, and liabilities totaling $140 million with duration of three years. If interest rates increase from 10% by 65 basis points, what is the change in the banks capitalization ratio? 9. The manager for Sun Trust Bank has the following assets to manage:

Asset Bonds Consumer loans Home loans Liability Demand deposits Saving accounts

Value $55,000,000 $475,000,000 $1500,000,000 Value $800,000,000 ??

Duration 3.60 2.50 6.00 Duration 2.00 0.50

If the manager wants a duration gap of 3.00, what level of saving accounts should the bank raise? Assume that any difference between assets and liabilities is held as cash.

10. A bank issues a $250,000 variable-rate 35-year mortgage with a nominal annual rate of 6.5%. If the required rate drops to 3.0% after the first six months, what is the impact on the interest income for the first 18 months?

11. A bank issues a $180,000 fixed-rate 25-year mortgage with a nominal annual rate of 4.0%. If the required rate drops to 3.0% immediately after the mortgage is issued, what is the impact on the value of the mortgage?

12. Calculate the duration of a $100,000 fixed-rate 30-year mortgage with a nominal annual rate of 9.5%. What is the expected percentage change in value if 13. The value of a $100,000 fixed-rate 30-year mortgage falls to $79,635 when interest rates move from 5% to 7%. What is the approximate duration of the mortgage? Ans:

14. Calculate the duration of a commercial loan. The face value of the loan is $5,000,000. It requires simple interest yearly, with an APR of 7%. The loan is due in four years. The current market rate for such loans is 6%.