Question

1.      Suppose Bank A has $40 million in rate-sensitive assets, $70 million in fixed rate assets, $70 million in rate sensitive liabilities, and $40 million in fixed rate liabilities and equity capital. (10 points)

a. What is the value of the bank’s GAP?

b. Calculate the change in Bank A’s profit as a result of a decrease in market interest rates of 3 percentage points.

c.   Calculate the change in Bank A’s profit as a result of an increase in market interest rates of 2 percentage points.

d. If you had believed that rates were going to rise by 2 percentage points (before it actually happened), explain how (if at all) you could have altered Bank A’s balance sheet and changed its interest rate risk exposure to improve its subsequent profit performance.

Answer 1

a. $40 million in rate-sensitive assets - $70 million in rate sensitive liabilities= -$30 million
b. A fall in market interest rates of 3 percentage points will increase the losses with -$30 million * 3 = -$90 million
c. An increase in market interest rates of 2 percentage points will reduce the losses with -$30 million * 2 = -$60 million
d. A fall in the rates of interest often reverses the profits into losses for the equal amounts. To avoid this variability in profit or the losses, the bank must raise the amount of interest rate sensitive assets it holds, decrease the rate sensitive liabilities it holds, or may engage in an swapping of the interest rate with another company.