Question

Company T with total assets of $370 million and equity of $35 million has a leverage...

Company T with total assets of $370 million and equity of $35 million has a leverage adjusted duration gap of +0.20 years. One-year maturity notes are currently priced at par and are paying 4.5 percent annually. Two-year maturity notes are currently priced at par and are paying 6 percent annually. The terms of a swap of $100 million notional value of liabilities' payments are 4.95 percent annual fixed payments in exchange for floating rate payments tied to the annual discount yield. Discuss your results.

a. What is the forward one-year discount yield expected next year?

b. What are the expected end-of-year profits or losses if the bank hedges its interest rate risk exposure using the swap?  

Homework Answers

Answer #1

a.  

Both the notes are trading at par, hence yield on the notes is same the coupon rate

Yield on one year maturity note, S1 = 4.5%

Yield on two year maturity note, S2 = 6%

One year discount yield expected next year = (1+ S2)^2/ (1+S1)^1 -1

= (1+6%)^2 / (1+4.5%)^1 -1

One year discount yield expected next year = 7.52%

If bank hedges its interest rate risk exposure with swaps, one year interest rates are expected to increase from 4.5% to 4.95%

% Change in net worth = - Duration Gap * (Change in interest rate / (1+original interest rates)

= - 0.2 * (4.95%-4.5%) / (1+4.5%)

= -0.086%

Expected change in Net worth (loss at the end of year) = 35 * -0.086%

= -$0.03 million

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
Company T with total assets of $370 million and equity of $35 million has a leverage...
Company T with total assets of $370 million and equity of $35 million has a leverage adjusted duration gap of +0.20 years. One-year maturity notes are currently priced at par and are paying 4.5 percent annually. Two-year maturity notes are currently priced at par and are paying 6 percent annually. The terms of a swap of $100 million notional value of liabilities' payments are 4.95 percent annual fixed payments in exchange for floating rate payments tied to the annual discount...
Company T with total assets of $370 million and equity of $35 million has a leverage...
Company T with total assets of $370 million and equity of $35 million has a leverage adjusted duration gap of +0.20 years. One-year maturity notes are currently priced at par and are paying 4.5 percent annually. Two-year maturity notes are currently priced at par and are paying 6 percent annually. The terms of a swap of $100 million notional value of liabilities' payments are 4.95 percent annual fixed payments in exchange for floating rate payments tied to the annual discount...
The Integrated Products Co. currently has debt with a market value of $280 million outstanding. The...
The Integrated Products Co. currently has debt with a market value of $280 million outstanding. The debt consists of 9 percent coupon bonds (paying semi-annually) that have a maturity of 15 years and are currently priced at $1440.03 per bond. The firm also has 12 million shares of common stock outstanding currently priced at $32.11 per share. The stock’s beta is 1.22, the market risk premium is 12.4% and T-bills yield 2.4%. If the company is subject to a 30%...
There are 2 million common shares of stock outstanding, currently trading for $35 per share. The...
There are 2 million common shares of stock outstanding, currently trading for $35 per share. The most recent dividend paid was $4 per share. Dividends are expected to increase by 2% per year for the foreseeable future. There are 25,000 bonds outstanding with a coupon rate of 5% that mature in eight years. The face value of these bonds is $1000, coupon payments are made annually, and the yield to maturity is 4%. There are 75,000 bonds outstanding with a...
Wonderful Ltd currently has 1.2 million ordinary shares outstanding and the share has a beta of...
Wonderful Ltd currently has 1.2 million ordinary shares outstanding and the share has a beta of 2.2. It also has $10 million face value of bonds that have 5 years remaining to maturity and 8% coupon rate with semi-annual payments, and are priced to yield 13.65%. If Wonderful issues up to $2.5 million of new bonds, the bonds will be priced at par and have a yield of 13.65%; if it issues bonds beyond $2.5 million, the expected yield on...
Peace Waterfront Ltd currently has 1.2 million ordinary shares outstanding and the share has a beta...
Peace Waterfront Ltd currently has 1.2 million ordinary shares outstanding and the share has a beta of 2.2. It also has $10 million face value of bonds that have 5 years remaining to maturity and 8% coupon rate with semi-annual payments, and are priced to yield 13.65%. If Peace Waterfront issues up to $2.5 million of new bonds, the bonds will be priced at par and have a yield of 13.65%; if it issues bonds beyond $2.5 million, the expected...
Peace Waterfront Ltd currently has 1.2 million ordinary shares outstanding and the share has a beta...
Peace Waterfront Ltd currently has 1.2 million ordinary shares outstanding and the share has a beta of 2.2. It also has $10 million face value of bonds that have 5 years remaining to maturity and 8% coupon rate with semi-annual payments, and are priced to yield 13.65%. If Peace Waterfront issues up to $2.5 million of new bonds, the bonds will be priced at par and have a yield of 13.65%; if it issues bonds beyond $2.5 million, the expected...
Consider the following capital structure for AAA Corporation. The company has one debt issue, preferred stock...
Consider the following capital structure for AAA Corporation. The company has one debt issue, preferred stock and common stock in its capital structure. The firm’s tax rate is 40%; the risk-free rate is 3%. Details on the components of the capital structure are listed below. Bond issue: Preferred equity: Common equity: Coupon-paying issue $100 million par 10% semiannual coupon Remaining maturity of 15 years Currently priced in market at 90% of par value Coupon-paying issue $50 million par 6% annual...
The Imaginary Products Co. currently has debt with a market value of $275 million outstanding. The...
The Imaginary Products Co. currently has debt with a market value of $275 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,392.42 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $11. The preferred shares pay an annual dividend of $1.20. Imaginary also has 14 million shares of common stock outstanding with a...
Suppose the First National Bank of Austin has $500.00 million in total assets with an average...
Suppose the First National Bank of Austin has $500.00 million in total assets with an average asset duration of five years. Assume that the bank’s liabilities are comprised of $86.75 million of demand deposits and $163.75 million in bonds with a 4.00% coupon rate (which pays annually) and a five year time-to-maturity. Further assume that current market interest rates are at 9.00% per annum. Show work. (a.) Calculate the duration of the bank’s bonds. (b.) What is this bank’s duration...