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Assume Merchants National Bank is operating a positive gap of $10 million and they decide to...

Assume Merchants National Bank is operating a positive gap of $10 million and they decide to take on $1.5 million of new interest bearing liabilities. After which interest rates subsequently rise from 4% to 7%. What effect will this have Merchants income?

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Answer #1

interest rate gap = interest bearing assets - interest bearing liabilities

current gap = $10 million

After taking on $1.5 million of new interest bearing liabilities, interest rate gap = $10 million - $1.5 million = $8.5 million

Increase in interest rates is beneficial in case of a positive gap, and detrimental in case of a negative gap

Effect on Merchants income would be positive (profit) as there is a positive gap

Increase in income = $8.5 million * (7% - 4%) = $255,000

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