Question

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1. Bank of RGV is a successful regional bank with common equity share outstanding 1 million. It pays $10 dividend each year and expected to grow 5% in period 1. The appropriate discount rate to reflect shareholder risk is 10%. Answer below question using below data pertains to Bank of RGV:

Below numbers are in 1000’s.

Balance sheet                                                      Income statement

Cash                                                   $100                Interest income                                       $400                                       

Securities investments                         $600                interest expense                                     ($150)

Net loans                                            $1,200             Non-interest income                             $50

Net premises and equip.                      $300             Non-interest expenses                        ($100)

           Total assets                              $2,200             Provision for loan losses                       ($60)

Deposits                                             $1,100                Pretax net operating income               $140

Non-deposit borrowings*                    $800                securities gains (loses)                          ($40)

Equity Capital                                     $300                Taxes                                                   ($45)

           Total liabilities                         $2,200             Net Income                                          $55

    *All purchased funds

a) What is the value of bank’s stock price? A. $200 per share  

$150 per share

$300 per share

$250 per share

$175 per share

What is the bank’s ROA and ROE?  

5% and 15%

7% and 19.5%

2.5% and 18.33%

10% and 5%

4% and 12.7%

What is the bank's asset utilization ratio?

5%

7%

2.5%

6.36%

12.7%

What is the bank's tax management?

39.28%

25.30%

42.55%

10%

4.8%

What is the bank’s Earning per share (EPS)?

5.5%

7.5%

2.5%

10%

4%

Bank of RGV currently has the following interest-sensitive assets and liabilities on its balance sheet with the interest-rate sensitivity weights noted.

Interest-Sensitive Assets	$ Amount	Rate Sensitivity Index
Federal fund loans	$75.00	1.00
Security holdings	$90.00	1.20
Loans and leases	$450.00	1.45
Interest-Sensitive Liabilities	$ Amount	Rate Sensitivity Index
Interest-bearing deposits	$325.00	0.75
Money-market borrowings	$80.00	0.95

What is the bank’s current interest-sensitive gap? Adjusting for these various interest rate sensitivity weights, what is the bank’s weighted interest-sensitive gap? a. $625 & $340

$200 & $500

$450 & $312

$500 & $350

$210 & $516

Suppose the federal funds interest rate change by 200 basis points (2%), how will the bank’s net interest income be affected given its current original and weighted balance sheet makeup?

increases by +4.2 and +10

decreases by -4.5 and -8      

increases by +2.5 and decreases by -5

decreases by -2 and increases by +4

None is correct

After you determine either the interest-sensitive gap is positive or negative, you should be able to determine the risk and possible management response. Considering the direction of interest sensitive gap, what would be your strategy to minimize the risk?

   

Extend asset maturity or shorten liability maturity

Extend liability maturity or shorten asset maturity

Do nothing market and let it recover by itself

Decrease overall asset books

Decrease overall liability books

RGV bank’s cash flows from assets (loans) and liabilities (deposits) are as follows:

    Expected Cash Inflows            Expected Cash Outflows            Annual Period in Which Cash Receipts

    from Assets                              from Liabilities                          Are Expected

    $1,275,600                                $1,295,500                                  Current year

    746,872                                    831,454                                       Two years from today

    341,555                                    123,897                                       Three years from today

If the discount rate applicable to the previous cash flows is 5.5%, what is the duration of the bank’ assets (D_A) and liabilities (D_L)? a. D_A = 5.6; D_L = 1.5

D_A = 1.6; D_L = 1.5

D_A = 3.8; D_L = 4.5

D_A = 1.7; D_L = 2.5            

D_A = 7.5; D_L = 1.85

What is the duration gap?

+2.50

-0.75

-1.80           d. +0.12

e. +0.60

If total assets are $15 billion and total liabilities are $10 billion, what is the leverage-adjusted duration gap? a. -2.50

+0.75

+1.80          d. -1.60

e. +0.60

If interest rates suddenly climb to 6%, what change will occur in the value of RGV bank’s net worth?

-5.2 Millions

-42,895

+5.2 Millions

+42,895

-1.5 Millions          

By how much would RGV bank’s net worth change if, instead of rising, interest rates fall from 5.5% to 5%?

-1.2 Millions

-42,895

+1.2 Millions

-5.2 Million

+42,895

4. Bank of South Texas reports an average asset duration of 9 years and an average liability duration of 4 years. In its latest financial report, the bank recorded total assets of $220 million and total liabilities of $190 million. If interest rates began at 1% and then suddenly climbed to 1.5%, what change will occur in the value of Bank of South Texas’s net worth? By how much would Bank of South Texas’s net worth change if, instead of rising, interest rates fall from 1% to 0.75%?

NW decrease by -10.4 millions and NW increase by 5 millions

NW decrease by -7.10 millions and NW increase by 3.5 millions

NW decrease by -5.2 millions and NW increase by 1 millions

NW decrease by -6.04 millions and NW increase by 3.02 millions

NW decrease by -4 millions and NW increase by 2.5 millions

          

5. Suppose a Bank of Texas (BoT) has an average asset duration of 4 years, an average liability duration of two years, total assets of $500 million, and liabilities of $450 million at a given point in time. Suppose, too, that the firm plans to trade in Treasury bond futures contracts. The T-bonds named in the futures contracts have a duration of 10 years, and the T-bonds’ current price is $99,700 per $100,000 contract. How many futures contracts does a BoT need to cover a given size risk exposure? What is the change in net worth of BoT, if interest rate increases from 2% to 5%. As we notice that BoT have positive duration gap (indicating its assets have longer average maturity than its liabilities). What sort of hedging strategy should BoT adopt if interest rate declines?

Required Futures contracts are 1103, Change in NW 550 millions , long hedge

Required Futures contracts are 2005, Change in NW 700 millions , short hedge

Required Futures contracts are 1000, Change in NW 905 millions , long hedge

Required Futures contracts are 1553, Change in NW 100 millions , long hedge

Required Futures contracts are 1300, Change in NW 50 millions , short hedge

6. Suppose investors expect a Bank of RGV to pay a $5 dividend at end of period 1, $12 at the end of   period 2, and then plan to sell the stock for a price of $120 per share at the end of period 2. If the risk-adjusted discount rate is 10%, the current value of the bank’s stock should be: a. 125

200

100

500

800

Answer 1

1.

Bank Stock Price = Expected dividend / (discount rate - growth rate)

= $10 / (10% - 5%)

= $200

Stock price of company is $200.

Option (A) is correct answer.

2.

Return on assets = Net Income / Total assets

= $55 / $2,200

= 2.50%

Return on assets is 2.50%.

Return on equity = Net Income / Total equity

= $55 / $300

= 18.33%

Return on equity is 18.33%

3.

bank asset utilization ratio = operating Income / Total assets

= $140 / $2,200

6.36%

bank asset utilization ratio is 6.36%.