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Bank Management and Financial Services 9th edition Peter Rose, Sylvia Hudgins - Solutions
When is a financial firm asset sensitive? Liability sensitive?
What is duration?
How is a financial institution’s duration gap determined?
How can you tell if you are fully hedged using duration gap analysis?
A government bond is currently selling for $1,195 and pays $75 per year in interest for 14 years when it matures. If the redemption value of this bond is $1,000, what is its yield to maturity if purchased today for $1,195?
Suppose the government bond described in problem 1 above is held for five years and then the savings institution acquiring the bond decides to sell it at a price of $940. Can you figure out the average annual yield the savings institution will have earned for its five-year investment in the bond?
U.S. Treasury bills are available for purchase this week at the following prices (based upon $100 par value) and with the indicated maturities:a. $97.25, 182 days.b. $95.75, 270 days.c. $98.75, 91 days.Calculate the bank discount rate (DR) on each bill if it is held to maturity. What is the
Farmville Financial reports a net interest margin of 2.75 percent in its most recent financial report, with total interest revenue of $95 million and total interest costs of $82 million. What volume of earning assets must the bank hold? Suppose the bank’s interest revenues rise by 5 percent and
If a credit union’s net interest margin, which was 2.50 percent, increases 10 percent and its total assets, which stood originally at $575 million, rise by 20 percent, what change will occur in the bank's net interest income?
The cumulative interest rate gap of Poquoson Savings Bank increases 60 percent from an initial figure of $25 million. If market interest rates rise by 25 percent from an initial level of 3 percent, what changes will occur in this thrift’s net interest income?
New Comers State Bank has recorded the following financial data for the past three years (dollars in millions):What has been happening to the bank€™s net interest margin? What do you think caused the changes you have observed? Do you have any recommendations for New Comers€™
The First National Bank of Dogsville finds that its asset and liability portfolio contains the following distribution of maturities and repricing opportunities:When and by how much is the bank exposed to interest rate risk? For each maturity or repricing interval, what changes in interest rates
Sunset Savings Bank currently has the following interest-sensitive assets and liabilities on its balance sheet with the interest-rate sensitivity weights noted.What is the bank€™s current interest-sensitive gap? Adjusting for these various interest rate sensitivity weights what is the
Sparkle Savings Association has interest-sensitive assets of $400 million, interest-sensitive liabilities of $325 million, and total assets of $500 million. What is the bank’s dollar interest-sensitive gap? What is Sparkle’s relative interest-sensitive gap? What is the value of its
Snowman Bank, N.A., has a portfolio of loans and securities expected to generate cash inflows for the bank as follows:Expected Cash Inflows of Principal and Interest Payments Annual Period in Which Cash Receipts Are Expected$1,275,600.............. Current year746,872............... Two years from
Given the cash inflow and outflow figures in Problem 11 for Snowman Bank, N.A., suppose that interest rates began at a level of 4.25 percent and then suddenly rise to 4.75 percent. If the bank has total assets of $20 billion and total liabilities of $18 billion, by how much would the value of
Conway Thrift Association reports an average asset duration of 7 years and an average liability duration of 4 years. In its latest financial report, the association recorded total assets of $1.8 billion and total liabilities of $1.5 billion. If interest rates began at 5 percent and then suddenly
A financial firm holds a bond in its investment portfolio whose duration is 15 years. Its current market price is $975. While market interest rates are currently at 6 percent for comparable quality securities, a decrease in interest rates to 5.75 percent is expected in the coming weeks. What change
A savings bank’s weighted average asset duration is 8 years. Its total liabilities amount to $925 million, while its assets total 1.25 billion dollars. What is the dollar-weighted duration of the bank’s liability portfolio if it has a zero leverage-adjusted duration gap?
Blue Moon National Bank holds assets and liabilities whose average durations and dollar amounts are as shown in this table:What is the weighted average duration of Blue Moon€™s asset portfolio and liability portfolio? What is the leverage-adjusted durationgap?
A government bond currently carries a yield to maturity of 6 percent and a market price of $1,168.49. If the bond promises to pay $100 in interest annually for five years, what is its current duration?
Carter National Bank holds $15 million in government bonds having a duration of 12 years. If interest rates suddenly rise from 6 percent to 7 percent, what percentage change should occur in the bonds’ market price?
What are financial futures contracts? Which financial institutions use futures and other derivatives for risk management?
How can financial futures help financial service firms deal with interest rate risk?
What is a call option?
What information do T-bond and Eurodollar futures option quotes contain?
Suppose market interest rates were expected to rise. What type of option would normally be used?
If market interest rates were expected to fall, what type of option would a financial institution’s manager be likely to employ?
What is the purpose of an interest-rate swap?
What is a long hedge in financial futures? A short hedge?
How do you interpret the quotes for financial futures in The Wall Street Journal?
Suppose a bank wishes to sell $150 million in new deposits next month. Interest rates today on comparable deposits stand at 8 percent but are expected to rise to 8.25 percent next month. Concerned about the possible rise in borrowing costs, management wishes to use a futures contract. What type of
What kind of futures hedge would be appropriate in each of the following situations?
Explain what is involved in a put option.
What is an option on a futures contract?
What rules and regulations have recently been imposed on the use of futures, options, and other derivatives? What does the Financial Accounting Standards Board (FASB) require publicly traded firms to do in accounting for derivative transactions?
What are the principal advantages and disadvantages of interest-rate swaps?
How can financial-service providers make use of interest-rate caps, floors, and collars to generate revenue and help manage interest rate risk?
Suppose a bank enters into an agreement to make a $10 million, three-year floating-rate loan to one of its best corporate customers at an initial rate of 8 percent. The bank and its customer agree to a cap and a floor arrangement in which the customer reimburses the bank if the floating loan rate
You hedged your bank’s exposure to declining interest rates by buying one June Treasury bond futures contract at the opening price on April 10, as presented in Exhibit 8-2. It is now Tuesday, June 10, and you discover that on Monday, June 9, June T-bond futures opened at 115-165 and settled at
Use the quotes of Eurodollar futures contracts traded on the Chicago Mercantile Exchange as shown below to answer the following questions:a. What is the annualized discount yield based on the €œlow€ index price for the nearestMarch contract?b. If your financial firm took a
What kind of futures or options hedges would be called for in the following situations?a. Market interest rates are expected to increase and your financial firm’s asset-liability managers expect to liquidate a portion of their bond portfolio to meet customers’ demands for funds in the upcoming
Your financial firm needs to borrow $500 million by selling time deposits with 180-day maturities. If interest rates on comparable deposits are currently at 3.5 percent, what is the cost of issuing these deposits? Suppose interest rates rise to 4.5 percent. What then will be the cost of these
In response to the above scenario, management sells 500, 90-day Eurodollar time deposits futures contracts trading at an index price of 98. Interest rates rise as anticipated and your financial firm offsets its position by buying 500 contracts at an index price of 96.98. What type of hedge is this?
It is March and Cavalier Financial Services Corporation is concerned about what an increase in interest rates will do to the value of its bond portfolio. The portfolio currently has a market value of $101.1 million, and Cavalier’s management intends to liquidate $1.1 million in bonds in June to
By what amount will the market value of a Treasury bond futures contract change if interest rates rise from 5 to 5.25 percent? The underlying Treasury bond has a duration of 10.48 years and the Treasury bond futures contract is currently being quoted at 113-06. (Remember that Treasury bonds are
Morning View National Bank reports that its assets have a duration of 7 years and its liabilities average 1.75 years in duration. To hedge this duration gap, management plans to employ Treasury bond futures, which are currently quoted at 112-170 and have a duration of 10.36 years. Morning View’s
You hedged your financial firm’s exposure to declining interest rates by buying one September call on Treasury bond futures at the premium quoted on April 15 as referenced in Exhibit 8-4.a. How much did you pay for the call in dollars if you chose the strike price of 11000? (Remember that option
Refer to the information given for problem 9. You hedged your financial firm’s exposure to increasing interest rates by buying one September put on Treasury bond futures at the premium quoted for April 15 of the same year (see Exhibit 8-4).a. How much did you pay for the put in dollars if you
You hedged your thrift institution’s exposure to declining interest rates by buying one December call on Eurodollar deposit futures at the premium quoted earlier on April 15 (see Exhibit 8-4).a. How much did you pay for the call in dollars if you chose the strike price of 972500? b. If December
You hedged your financial firm’s exposure to increasing interest rates by buying one December put on Eurodollar deposit futures at the premium quoted earlier on April 15 (see Exhibit 8-4).a. How much did you pay for the put in dollars if you chose the strike price of 977500? b. If December
A bank is considering the use of options to deal with a serious funding cost problem. Deposit interest rates have been rising for six months, currently averaging 5 percent, and are expected to climb as high as 6.75 percent over the next 90 days. The bank plans to issue $60 million in new money
Hokie Savings wants to purchase a portfolio of home mortgage loans with an expected average return of 6.5 percent. Management is concerned that interest rates will drop and the cost of the portfolio will increase from the current price of $50 million. In six months when the funds become available
A savings and loan’s credit rating has just slipped, and half of its assets are long term mortgages. It offers to swap interest payments with a money center bank in a $100 million deal. The bank can borrow short term at LIBOR (3 percent) and long term at 3.95 percent. The S&L must pay LIBOR plus
A financial firm plans to borrow $100 million in the money market at a current interest rate of 4.5 percent. However, the borrowing rate will float with market conditions. To protect itself, the firm has purchased an interest-rate cap of 5 percent to cover this borrowing. If money market interest
Suppose that Gwynn’s Island Savings Association has recently granted a loan of $2 million to Oyster Farms at prime plus 0.5 percent for six months. In return for granting Oyster Farms an interest-rate cap of 6.5 percent on its loan, this thrift has received from this customer a floor rate on the
What does securitization of assets mean?
What advantages do sales of loans have for lending institutions trying to raise funds?
How can loan servicing be used to increase income?
Who are the principal parties to a standby credit agreement?
Why were credit derivatives developed? What advantages do they have over loan sales and securitizations, if any?
What is a credit swap? For what kinds of situations was it developed?
What is a total return swap? What advantages does it offer the swap beneficiary institution?
Of what use are credit-linked notes?
What are Collateralized Debt Obligations (CDOs)? How do they differ from other credit derivatives?
What advantages does securitization offer to the lending institutions?
What risks of securitization should the managers of lending institutions be aware of?
Suppose that a bank securitizes a package of its loans that bears a gross annual interest yield of 13 percent. The securities issued against the loan package promise interested investors an annualized yield of 8.25 percent. The expected default rate on the packaged loans is 3.5 percent. The bank
What are the risks of using loan sales as a significant source of funding for banks and other financial institutions?
What are standby credit letters? Why have they grown so rapidly in recent years?
What risks accompany a standby credit letter for (a) the issuer and (b) the beneficiary?
How can a lending institution mitigate the risks inherent in issuing standby credit letters?
How do credit options work? What circumstances result in the option contract paying off?
When is a credit default swap useful? Why?
What risks do credit derivatives pose for financial institutions using them? In your opinion what should regulators do about the recent rapid growth of this market, if anything?
GoodLife National Bank placed a group of 10,000 consumer loans bearing an average expected gross annual yield of 6 percent in a package to be securitized. The investment bank advising GoodLife estimates that the securities will sell at a slight discount from par that results in a net interest cost
Jasper Corporation is requesting a loan for repair of some assembly-line equipment in the amount of $10.25 million. The nine-month loan is priced by Farmers Financial Corporation at a 6.5 percent rate of interest. However, the finance company tells Jasper that if it obtains a suitable credit
The Pretty Lake Bank Corp. has placed $100 million of GNMA-guaranteed securities in a trust account off the balance sheet. A CMO with four tranches has just been issued by Pretty Lake using the GNMAs as collateral. Each tranche has a face value of $25 million and makes monthly payments. The annual
First Security National Bank has been approached by a long-standing customer, United Safeco Industries, for a $30 million term loan for five years to purchase new stamping machines that would further automate the company’s assembly line in the manufacture of metal toys and containers. The company
What type of credit derivatives contract would you recommend for each of the following situations:a. A bank plans to issue a group of bonds backed by a pool of credit card loans but fears that the default rate on these credit card loans will rise well above 6 percent of the portfolio – the
Why do banks and other institutions choose to devote a significant portion of their assets to investment securities?
What key roles do investments play in the management of a depository institution?
What are the principal money market and capital market instruments available to institutions today? What are their most important characteristics?
What types of investment securities do banks seem to prefer the most? Can you explain why?
What are securitized assets? Why have they grown so rapidly in recent years?
What special risks do securitized assets present to institutions investing in them?
What are structured notes and stripped securities? What unusual features do they contain?
How is the expected yield on most bonds determined?
If a government bond is expected to mature in two years and has a current price of $950, what is the bond's YTM if it has a par value of $1,000 and a promised coupon rate of 10 percent? Suppose this bond is sold one year after purchase for a price of $970. What would this investor's holding period
What forms of risk affect investments?
How has the tax exposure of various U.S. bank security investments changed in recent years?
Suppose a corporate bond an investments officer would like to purchase for her bank has a before-tax yield of 8.98 percent and the bank is in the 35 percent federal income tax bracket. What is the bond's after-tax gross yield? What after-tax rate of return must a prospective loan generate to be
What is the net after-tax return on a qualified municipal security whose nominal gross return is 6 percent, the cost of borrowed funds is 5 percent, and the financial firm holding the bond is in the 35 percent tax bracket? What is the tax-equivalent yield (TEY) on this tax-exempt security?
What is tax swapping? What is portfolio shifting? Give an example of each.
Why do depository institutions face pledging requirements when they accept government deposits?
What types of securities are used to meet collateralization requirements?
What maturity strategies do financial firms employ in managing their portfolios?
Bacone National Bank has structured its investment portfolio, which extends out to four-year maturities, so that it holds about $11 million each in one-year, two-year, three-year, and four-year securities. In contrast, Dunham National Bank and Trust holds $36 million in one- and two-year securities
How can the yield curve and duration help an investments officer choose which securities to acquire or sell?
A bond currently sells for $950 based on a par value of $1,000 and promises $100 in interest for three years before being retired. Yields to maturity on comparable-quality securities are currently at 12 percent. What is the bond’s duration? Suppose interest rates in the market fall to 10
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