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Bank Management 8th edition Timothy W. Koch, S. Scott MacDonald - Solutions
Suppose that a zero coupon bond selling at $ 1,000 par has a duration of four years. If interest rates increase from 6 percent to 7 percent annually, the value of the bond will fall by what amount using Equation 6.14? Use semiannual compounding. Then, use the PV formula to determine the actual
If interest rates fall from 6 percent to 5 percent, the price of the bond in the above problem will increase. Will the change in price (regardless of sign) be smaller or larger than in the above problem? Show how much by using the PV formula, Equation 6.8, and Equation 6.14. How does this
Consider a $ 15,000 loan with interest at 12 percent compounded monthly and 24 monthly payments. How much will the loan payment be? Set up an amortization schedule for the first four months, indicating the amount and timing of principal and interest payments.
What is the bond equivalent yield of a 180- day, $ 1 million face value Treasury bill with a discount rate of 4.5 percent?
You would like to purchase a T- bill that has a $ 10,000 face value and 270 days to maturity. The current price of the T- bill is $ 9,860. What is the discount rate on this security? What is its bond equivalent yield?
You have just purchased a five- year maturity bond for $ 10,000 par value that pays $ 610 in coupon interest annually ($ 305 every six months). You expect to hold the bond until maturity. Calculate your expected total return if you can reinvest all coupon payments at 5 percent (2.5 percent
You are planning to buy a corporate bond with a seven year maturity that pays 7 percent coupon interest. The bond is priced at $ 108,500 per $ 100,000 par value. You expect to sell the bond in two years when a similar risk five year bond is priced to yield 7.2 percent annually to maturity. Assuming
You buy 100 shares in Bondex Corporation for $ 25 a share. Each share pays $ 1 in dividends every three months. You have a five year holding period and expect to invest all dividends received in the first two years at 6 percent, and all dividends received the next three years at 9 percent.
What is the effective interest rate of 10 percent compounded quarterly, versus 10 percent compounded monthly?
Consider a $ 15,000 loan with interest at 12 percent compounded monthly and 24 monthly payments. How much will the loan payment be? Set up an amortization schedule for the first four months, indicating the amount and timing of principal and interest payments. Discuss.
How much would you be willing to pay today for an investment that will return $ 6,800 to you eight years from today if your required rate of return is 12 percent?
Six years ago you placed $ 250 in a savings account which is now worth $ 1,040.28. When you put the funds into the account, you were told it would pay 24 percent interest. You expected to find the account worth $ 908.80. What compounding did you think this account used, and what did it actually use?
If you invest $ 9,000 today at 8 percent compounded annually, but after three years the interest rate increases to 10 percent compounded semiannually, what is the investment worth seven years from today?
Suppose a customer’s house increased in value over five years from $ 150,000 to $ 250,000. What was the annual growth rate of the property value during this five-year interval? Three local banks pay different interest rates on time deposits with one- year maturities. Rank the three banks from
You want to buy a new car, but you know that the most you can afford for payments is $ 375 per month. You want 48 month financing, and you can arrange such a loan at 6 percent compounded monthly. You have nothing to trade and no down payment. The most expensive car you can purchase is (1) an old
List the basic steps in static GAP analysis. What is the objective of each?
An embedded option associated with each of the following instruments potentially alters the rate sensitivity of the underlying instrument. Indicate when the option is typically exercised and how it affects rate sensitivity. The current prime rate is 3.25 percent. a. Fixed- rate mortgage loan with a
What information is available from earnings sensitivity analysis that is not provided by static GAP analysis?
Assume that you manage the interest rate risk position for your bank. Your bank currently has a positive cumulative GAP for all time intervals through one year. You expect that interest rates will fall sharply during the year and want to reduce your bank’s risk position. The current yield curve
Interpret the following earnings at risk data. What does it suggest regarding the bank’s risk exposure? Earnings- at- Risk Interest Rate Change (%) 1 Year 2 Years + 1% shock + 2.4% + 4.9% - 1% shock - 1.7% - 5.5% - 1% yield curve inversion + 1.1% - 2.6%
Given the following information for AmBank, calculate its income statement (effective) GAP. How much will NII change if the prime rate rises 1 percent? The ECR reflects the relationship of each account's rate to the prime rate.
Are the following assets rate sensitive within a six- month time frame? Explain. a. Three- month T- bill b. Federal funds sold (daily repricing) c. Two- year Treasury bond with semiannual coupon payments d. Four- year fully amortized car loan with $ 350 monthly payments including both principal and
Consider the following bank balance sheet and associated average interest rates. The time frame for rate sensitivity is one year. Figures are in thousands.a. Calculate the bank’s GAP, expected NII, and NIM if interest rates and portfolio composition remain constant during the year. This bank is
Suppose that your bank buys a T- bill yielding 4 percent that matures in six months and finances the purchase with a three month time deposit paying 3 percent. The purchase price of the T- bill is $ 3 million financed with a $ 3 million deposit. a. Calculate the six month GAP associated with this
What is the fundamental weakness of the GAP ratio as compared with GAP as a measure of interest rate risk?
Discuss the problems that loans tied to a bank’s base rate present in measuring interest rate risk where the base rate is not tied directly to a specific market interest rate that changes on a systematic basis.
Consider the following asset and liability structures:County Bank Asset: $ 10 million in a one- year, fixed- rate commercial loan Liability: $ 10 million in a three- month CDCity Bank Asset: $ 10 million in a three- year, fixed- rate commercial loan Liability: $ 10 million in a six- month
Consider the following asset and liability structures:County Bank Asset: $ 10 million in a one- year, fixed- rate commercial loan Liability: $ 10 million in a three- month CDCity Bank Asset: $ 10 million in a three- year, fixed- rate commercial loan Liability: $ 10 million in a six- month CDa. Is
Assume that you manage the interest rate risk position for your bank. Your bank currently has a positive cumulative GAP for all time intervals through one year. You expect that interest rates will fall sharply during the year and want to reduce your bank’s risk position. The current yield curve
List the basic steps in DGAP analysis. What is the importance of different interest rate forecasts?
Suppose that your bank currently operates with a DGAP of 2.2 years. Which of the following will serve to reduce the bank’s interest rate risk? a. Issue a one year zero coupon CD to a customer and use the proceeds to buy a three year zero coupon Treasury bond. b. Sell $ 5 million in one year
ALCO members are considering the following EVE sensitivity estimates. The figures refer to the percentage change in economic value of equity compared with the base rate forecast scenario. What does the information say about the bank’s overall interest rate risk? Discuss the role and impact of
Discuss what impact each of the following will have, in general, on EVE sensitivity to a change in interest rates. Consider two cases where rates rise sharply and fall sharply. a. Bank owns a high percentage of assets in bonds that are callable anytime after three months. b. Bank pays below market
Which has a longer Macaulay’s duration: a $ 1 million face value zero coupon bond with a two- year maturity and a yield of 6 percent, or a $ 1 million face value coupon bond with a two- year maturity that pays 6 percent coupon interest? Explain your reasoning.
You own a corporate bond that carries a 5.8 percent coupon rate and pays $ 10,000 at maturity in exactly two years. The current market yield on the bond is 6.1 percent. Coupon interest is paid semiannually and the market price is $ 9,944.32. a. Calculate the bond’s Macaulay’s duration and
Assume that you own a $ 1 million par value corporate bond that pays 7 percent in coupon interest (3.5 percent semiannually), has four years remaining to maturity, and is immediately callable at par. Its current market yield is 7 percent and it is priced at par. If rates on comparable securities
A 5- year zero coupon bond and a 15- year zero coupon bond both carry a price of $ 7,500 and a market rate of 8 percent. Assuming that the market rates on both bonds fall to 7 percent, calculate the percentage change in each bond’s price.
Use DGAP analysis to determine if there is interest rate risk in the following transaction: A bank obtains $ 25,000 in funds from a customer who makes a deposit with a five- year maturity that pays 5 percent annual interest compounded daily. All interest and principal are paid at the end of five
Compare the strengths and weaknesses of GAP and earnings sensitivity analysis with DGAP and EVE sensitivity analysis.
Is the following statement generally true or false? Provide your reasoning. “A bank with a negative GAP through three years will have a positive DGAP.”
Conduct DGAP analysis using the following information:a. Calculate the bank's DGAP if the ALCO targets the economic value of stockholders equity. Is this bank positioned to gain or lose if interest rates rise? b. Estimate the change in economic value of equity if all market interest rates fall by
How does a futures contract differ from a forward contract?
Explain how macrohedging differs from microhedging.
A bank has assets of $ 10 million earning an average yield of 5 percent with a weighted duration of 1.5 years. It has liabilities of $ 9 million paying an average rate of 1.5 percent with a weighted duration of 3.5 years. The bank wants to construct a macrohedge to reduce interest rate risk as much
What are the risks in a FRA if you are the buyer?
Assume that you want to speculate on how six month cash market LIBOR now equal to 1.95% will move over the next year. You believe that consensus forecasts of future rates are too high. You can enter into an FRA and agree either to pay 2.25 percent and receive six month LIBOR, or pay six month LIBOR
It is January 1. Your firm expects to issue (borrow) three- month Eurodollar time deposits at the beginning of February, May, August, and November in the next year. Explain what position(s) you would take today with FRAs based on three-month LIBOR if you wanted to fully hedge your future
Discuss the role of a third party intermediary in an interest rate swap agreement. Describe the risks assumed by the intermediary. How does the intermediary potentially profit from this activity?
What features of interest rate swaps make them more or less attractive than financial futures as a risk management tool?
Is there credit risk in an interest rate swap with an intermediary bank serving as the swap dealer? Describe when default losses might arise and which party is at risk. Explain how credit risk can be reduced.
A basic interest rate swap is priced as a zero net present value transaction. Explain what this means. Use the two year swap data to demonstrate your arguments.
Your firm just made a three year, fixed rate loan at 6.25 percent. You would like to convert this to a floating rate loan that is priced based on three month LIBOR as the base rate. Explain how you could use a basic interest rate swap to accomplish this. Using the data, choose swap terms that
It is said that a microhedge does not totally eliminate risk. Assume that a bank uses financial futures contracts to reduce the risk of rising rates on new borrowings. Identify what type of position the bank should take to hedge. Once a hedge is in place, what risks remain?
Your bank is looking for the lowest cost two year, fixed rate financing. It has decided to issue four consecutive three month Eurodollar time deposits on balance sheet and hedge the future borrowing costs by taking positions in the market for basic interest rate swaps. What positions are
What are the risks in a FRA if you are the buyer?Answer the following questions: a. When will the buyer of a five year cap on three- month LIBOR with a 1 percent strike rate expect to receive cash? What is the cap premium? b. When will the buyer of a two year floor on three- month LIBOR with a 0.25
Explain how the outcome from using a basic interest rate swap to hedge borrowing costs will generally differ from using an interest rate cap and an interest rate collar as hedges. Why is there a difference?
In each of the following cases, indicate whether an interest rate cap, floor, collar, or reverse collar is an appropriate position for a hedge. Recommend a specific position. a. A bank loan customer wants to borrow at a fixed 8 percent rate and the bank only lends at floating rates. b. A bank has
Suppose that the yield curve on Eurodollars is sharply upward- sloping. a. Will premiums on interest rate floors on three- month LIBOR be high or low? Explain. b. Will premiums on interest rate caps on three- month LIBOR be high or low? Explain.
Assume that you bought an interest rate cap on three- month LIBOR with a 2.50 percent strike rate. The current rate for three- month LIBOR is 2.28 percent. a. What will happen to the premium (value) on this cap if LIBOR rises to 3.16 percent? Explain. b. What will happen to the premium (value) on
Your bank is asset sensitive, and management wants to protect against loss from interest rate changes. a. Would an interest rate cap or floor serve as a better hedge? Explain. b. Would a collar or reverse collar serve as a better hedge? Explain. c. Why would the bank choose a collar or reverse
Suppose that you buy an interest rate cap on three month LIBOR with a two year maturity and simultaneously sell a floor on three month LIBOR with a two year maturity. Ignore the premiums. Draw a profit diagram that indicates when you will gain and lose on the combined positions. Compare this with
Are there margin requirements for the following positions? Explain why or why not. a. Buy an interest rate cap b. Sell a put option on Eurodollar futures c. Sell an interest rate floor d. Sell a Eurodollar futures contract
Some analysts compare the initial margin on a futures contract to a down payment. Some label it a performance bond. What is the difference between these interpretations?
Suppose that you are a speculator who trades three- month Eurodollar futures. On November 5, you sell two December three- month Eurodollar futures contracts at 96.81. The subsequent weekly quotes for the closing December Eurodollar futures price are as follows: Date: 11/ 12 11/ 19 11/ 26
Suppose that you are a speculator who tries to time interest rate movements on three- month Eurodollar futures contracts. To answer the following questions, use the data in Exhibits 9.1 and 9.2, and assume that it is February 18, 2014. a. What is the three- month Eurodollar rate in the cash market?
Explain why cross hedges generally exhibit greater risk than hedges using a futures contract based on the underlying cash instrument hedged.
In each of the following cases, conduct the analysis for Step 1 and Step 2 (page 339 in this chapter) in evaluating a hedge. Specifically assess cash market risk and determine whether the bank should buy or sell financial futures as a hedge. Explain how the hedge should work. a. The bank expects
A bank plans to hedge using three month Eurodollar futures contracts based on $ 1 million in principal. Determine how many contracts the bank should trade (its hedge ratio) in the following situations: a. The bank will roll over $ 125 million in six month CDs in four months. The Eurodollar futures
A bank that hedges with financial futures cannot completely eliminate interest rate risk. Explain what basis risk is and why it exists. Is it ever possible to eliminate basis risk?
The typical low balance customer at your bank with an average monthly demand deposit balance under $ 175 exhibits the following monthly activity: 35 withdrawals (11 electronic), two transit checks deposited, one transit check cashed, two deposits (one electronic), and one on us check cashed per
What types of bank liabilities generate the highest servicing costs? What types generate the highest acquisition costs?
Use the following information to estimate the marginal cost of issuing a $ 1 million CD paying 3.25 percent interest. It has a one- year maturity and the following estimates apply relative to the balance obtained: Acquisition costs = 1/ 8 of 1 percent FDIC insurance = 1/ 12 of 1 percent required
The weighted marginal cost of funds is used in pricing decisions. Explain how it should be used if the loan being priced exhibits average risk. How should the weighted marginal cost of funds be used if the loan carries above average risk?
What are the different types of cash assets and the basic objectives for holding each?
In many cases, banks do not permit depositors to spend the proceeds of a deposit until several days have elapsed. What risks do banks face in the check clearing process? Does this justify holds on checks?
What is the difference between a correspondent, respondent, and bankers’ bank?
What do the terms core deposits and volatile, or noncore, deposits mean? Explain how a bank might estimate the magnitude of each.
Explain how each of the following will affect a bank’s deposit balances at the Federal Reserve: a. The bank ships excess vault cash to the Federal Reserve. b. The bank buys U. S. government securities in the open market. c. The bank realizes a surplus in its local clearinghouse processing. d.
18. Banks must pledge collateral against four different types of liabilities. Which liabilities require collateral, what type of collateral is required, and what impact do the pledging requirements have on a bank’s asset liquidity?
Explain how a bank’s credit risk and interest rate risk can affect its liquidity risk.
Indicate how a bank’s core deposits differ from its wholesale liabilities in terms of interest elasticity. What factors are relatively more important for attracting and retaining core deposits as compared with purchased funds?
What can a bank do to increase its core deposits? What are the costs and benefits of such efforts? Generally, how might management estimate the relative interest elasticity of various deposit liabilities of a bank?
What are trusts preferred securities? What role did they play in the recent financial crisis?
Explain why the Federal Reserve extended discount window loans to Goldman Sachs, American Express, Citigroup, Bank of America, and other large banking organizations during the recent financial crisis.
Determine the average monthly cost of servicing the typical student’s demand deposit account, which generates 27 withdrawals (15 electronic), two transit checks deposited, two transit checks cashed, two deposits (one electronic), and one on us check cashed per month. Assume there is one account
Assume the following transactions occur sequentially: a. The DMV Corporation, based in New Orleans, converts a $ 3 million demand deposit held at the New York Money Center Bank to a $ 3 million Eurodollar deposit held at Barclays Bank in London. b. Barclays Bank opens a $ 3 million Eurodollar
As a potential jumbo CD depositor, under what circumstances would you prefer a variable rate CD over a fixed rate CD? Under what circumstances would you prefer a zero coupon CD over a variable rate CD?
How large would Barnett’s uninsured deposits be in these FDIC insured banks if the funds were held at the same point in time? a. Barnett owns a joint account with his sister for $ 175,000 in Metro Bank. b. Barnett owns an account in his name only for $ 80,000 in Metro Bank. c. Barnett owns a
Identify whether you should use an average cost of bank funds or a marginal cost of funds in the following situations. a. Setting the rate on a new loan b. Evaluating the profitability of a long standing customer’s relationship c. Calculating the bank’s income tax liability d. Deciding
What are the consequences of a bank mistakenly pricing loans based on the historical cost of funds? Do they differ in a rising rate environment versus a falling rate environment?
The determination of cash requirements is closely associated with a bank’s liquidity requirements. Explain why.
What are the key components of a bank’s contingency funding plan? What are the differences between the narrative section and the quantitative section?
Assume that a bank expects to access each of the following sources of funds in the event of an unanticipated liquidity need. In what situations might the counterparty not supply the promised funding? a. $ 5 million federal funds line with a large regional bank b. $ 10 million borrowing capacity,
Explain the role that the Federal Reserve played in providing loans to financial institutions during the financial crisis of 2007– 2010.
What does the acronym TBTF refer to in banking terminology? Provide an example of a TBTF firm indicating what makes it TBTF.
Monetary theory examines the role of excess reserves (actual reserves minus required reserves) in influencing economic activity and Federal Reserve monetary policy. Viewed in the context of a single bank, excess reserves are difficult to measure. Explain what amount of a bank’s actual reserve
Which of the following activities will affect a bank’s required reserves? a. The local Girl Scout troop collects coins and currency to buy a new camping stove. The troop deposits $ 250 in coins and opens a small time deposit. b. You decide to move $ 200 from your MMDA to your NOW account. c.
A corporate customer borrows $ 150,000 against the firm’s credit line at a local bank. Indicate with a T- account how the transaction will affect the bank’s deposit balances held at the Federal Reserve when the firm spends the proceeds.
Liquidity planning requires monitoring deposit outflows. In each of the following situations, which of the outflows are discretionary and which are not? If the outflow is not discretionary, is it predictable or unexpected? a. In April, a farmer draws down his line of credit in order to purchase
Your bank’s estimated liquidity gap over the next 90 days equals $ 180 million. You estimate that projected funding sources over the same 90 days will equal only $ 150 million. What planning and policy requirements does this impose on your $ 3 billion bank?
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