Question

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

Assets			Liabilities and Equity
Floating-rate mortgages      (currently 13% p.a.)	$	88	Now deposits      (currently 9% p.a.)	$	125
30-year fixed-rate loans      (currently 10% p.a.)		110	5-year time deposits      (currently 9% p.a.)		32
			Equity		41
Total	$	198	Total	$	198

a.	What is Watchover’s expected net interest income at year-end? (Enter your answer in millions rounded to 2 decimal places. (e.g., 32.16))

Net interest income

$  million

b.	What will be the net interest income at year-end if interest rates rise by 1 percent? (Enter your answer in millions rounded to 2 decimal places. (e.g., 32.16))

Net interest income

$  million

c.	Using the one-year cumulative repricing gap model, what is the change in the expected net interest income for a 1 percent increase in interest rates? (Negative amount should be indicated by a minus sign. Enter your answer in millions rounded to 2 decimal places. (e.g., 32.16))

Net interest income

$  million

Answer 1

a. What is WatchoverU’s expected net interest income at year-end?

Current expected interest income: $88m(0.13) + $110m(0.10) = $22.44m.

Expected interest expense: $125m(0.09) + $32m(0.09) = $14.13m .

Expected net interest income: $22.44m - $14.13m = $8.31m.

b. What will be the net interest income at year-end if interest rates rise by 1 percent?

After the 1 percent interest rate increase, net interest income declines to:

88(.14) +110(.10) – 125(.10) – 32(0.09) = $9.5m - $7.0m = $7.94m, a decline of $0.37m.

c. Using the one-year cumulative repricing gap model, what is the change in the expected net interest income for a 1 percent increase in interest rates?

WatchoverU’s repricing or funding gap is $88m - $110m = -$22m. The change in net interest income using the funding gap model is (-$22m)(0.01) = -$0.22m.