Question

Consider the following bank balance sheet (fixed rates and pure discount securities unless indicated otherwise). Interest rates on liabilities are 10 percent and on assets are 12 percent. Assets $m Duration (years) Liabilities and Equity $m Duration (years) Prime-Rate Loans (rates set daily) 50 1.0 Super Now Checking Accounts (rates set daily) 100 1.0 2-Year Car Loans 65 1.0 6-Month Certificates of Deposit 40 0.5 30-Year Mortgages 60 7.0 3-Year Certificates of Deposit 25 3.0 Total Assets 175 ? Total Liabilites 165 ? Equity (E) 10 --  a. What is the duration of assets, DA, liabilites, DL, and Equity, E. b. The bank will benefit or be hurt if all interest rates rise (assume by the same amount). c. Compute the repricing gap for the bank using those assets and liabilities repricing or maturing in 2 years or less. From this information, will the bank be hurt or benefit by a 200 basis point rise in interest rates on assets and liabilities? d. If the bank gets an additional $100 in a 6-month certificate of deposit, what investments (using the above portfolio possibilities) should it make to control interest rate risk ( y = � 200 basis point change in all interest rates) by changing the duration of its portfolio? State the advantages and disadvantages of using net worth immunization and asset/liability duration as a means of controlling interest rate risk. Define your terms.

Answer 1

SOLUTON:-

Year	0	1	2	3	4	5
Equipment Cost	(600,000)
Net Revenue		300,000	315,000	330,750	347,288	364,652
Less :Labor/Maintenance costs		(100,000)	(105,000)	110,250)	(115,763)	(121,551)
Utilities Costs		10,000	10,500	11,025	11,576	12,155
Supplies
Incremental overhead		5,000	5,000	5,000	5,000	5,000
Operating Income	(600,000)	215,000	225,500	236,525	248,101	260,256
Equipment Salvage Value						200,000
Net Cash Flow	(600,000)	215,000	225,500	236,525	248,101	460,256
PV of cash flow at 10%	(600,000)	195,455	186,364	177,705	169,456	285,783
Npv	414,762
IRR	31.3%

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