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financial institutions management

Financial Institutions Management 8th Edition Anthony Saunders, Marcia Cornett - Solutions

What is the gap to total assets ratio? What is the value of this ratio to interest rate risk managers and regulators?
What are the reasons for not including demand deposits as rate-sensitive liabilities in the repricing analysis for a commercial bank? What is the subtle but potentially strong reason for including demand deposits in the total of rate sensitive liabilities? Can the same argument be made for passbook
Premises 6.25$337.50 $337.50a. Calculate the value of MMC’s rate-sensitive assets, rate-sensitive liabilities, and repricing gap over the next year.b. Calculate the expected change in the net interest income for the bank if interest rates rise by 1 percent on both RSAs and RSLs. If interest rates
Two-year time deposits 50.00
30-year, floating-rate mortgages 50.00
One-year time deposits 25.00
10-year, fixed-rate mortgages 25.00
Six-month commercial paper 75.00
Three-year T-bonds 75.00
Three-month bankers’ acceptances 25.00
Six-month T-notes 43.75
Three-month CDs 50.00
Three-month T-bills 37.50
Passbook savings 37.50
Long-term consumer loans(two-year maturity) 31.25
Demand deposits 50.00
Short-term consumer loans(one-year maturity) 62.50
Equity capital (fixed) $ 25.00
Cash and due from $ 6.25
Consider the following balance sheet for MMC Bancorp (in millions of dollars):Assets Liabilities
Consider the following balance sheet positions for a financial institution:• Rate-sensitive assets $200 million Rate-sensitive liabilities $100 million• Rate-sensitive assets $100 million Rate-sensitive liabilities $150 million• Rate-sensitive assets $150 million Rate-sensitive
Which of the following is an appropriate change to make on a bank’s balance sheet when GAP is negative, spread is expected to remain unchanged, and interest rates are expected to rise?a. Replace fixed-rate loans with rate-sensitive loans.b. Replace marketable securities with fixed-rate loans.c.
What is the CGAP effect? According to the CGAP effect, what is the relation between changes in interest rates and changes in net interest income when CGAP is positive? When CGAP is negative?
What is a maturity bucket in the repricing model? Why is the length of time selected for repricing assets and liabilities important in using the repricing model?
What is the repricing gap? In using this model to evaluate interest rate risk, what is meant by rate sensitivity? On what financial performance variable does the repricing model focus? Explain.
How has the increased level of financial market integration affected interest rates?
Consider these four types of risks: credit, foreign exchange, market, and sovereign. These risks can be separated into two pairs of risk types in which each pair consists of two related risk types, with one being a subset of the other.How would you pair off the risk types, and which risk type could
Discuss the interrelationships among the different sources of FI risk exposure.Why would the construction of an FI risk management model to measure and manage only one type of risk be incomplete?
Why can insolvency risk be classified as a consequence or outcome of any or all of the other types of risks?
What is the difference between technology risk and operational risk? How does internationalizing the payments system among banks increase operational risk?
What is technology risk? What is the difference between economies of scale and economies of scope? How can these economies create benefits for an FI? How can these economies prove harmful to an FI?
What is the nature of an off-balance-sheet activity? How does an FI benefit from such activities? Identify the various risks that these activities generate for an FI, and explain how these risks can create varying degrees of financial stress for the FI at a later time.
What is market risk? How does this risk affect the operating performance of financial institutions? What actions can be taken by an FI’s management to minimize the effects of this risk?
What is country or sovereign risk? What remedy does an FI realistically have in the event of a collapsing country or currency?
Suppose you purchase a 10-year, AAA-rated Swiss bond for par that is paying an annual coupon of 6 percent. The bond has a face value of 1,000 Swiss francs(SF). The spot rate at the time of purchase is SF1.15/$. At the end of the year, the bond is downgraded to AA and the yield increases to 8
Six months ago, Qualitybank issued a $100 million, one-year maturity CD denominated in euros. On the same date, $60 million was invested in a:-denominated loan and $40 million was invested in a U.S. Treasury bill. The exchange rate on this date was :1.5675/$. Assume no repayment of principal and an
A U.S. insurance company invests $1,000,000 in a private placement of British bonds. Each bond pays £300 in interest per year for 20 years. If the current exchange rate is £1.564/$, what is the nature of the insurance company’s exchange rate risk? Specifically, what type of exchange rate
If an FI has the same amount of foreign assets and foreign liabilities in the same currency, has that FI necessarily reduced the risk involved in these international transactions to zero? Explain.
If international capital markets are well integrated and operate efficiently, will FIs be exposed to foreign exchange risk? What are the sources of foreign exchange risk for FIs?
If the Swiss franc is expected to depreciate in the near future, would a U.S.-based FI in Bern City prefer to be net long or net short in its asset positions? Discuss.
What is foreign exchange risk? What does it mean for an FI to be net long in foreign assets? What does it mean for an FI to be net short in foreign assets? In each case, what must happen to the foreign exchange rate to cause the FI to suffer losses?
What two factors provide potential benefits to FIs that expand their asset holdings and liability funding sources beyond their domestic borders?
Consider the simple FI balance sheet below (in millions of dollars).Suppose that depositors unexpectedly withdraw $50 million in deposits and the FI receives no new deposits to replace them. Assume that the FI cannot borrow any more funds in the short-term money markets, and because it cannot wait
What is liquidity risk? What routine operating factors allow FIs to deal with this risk in times of normal economic activity? What market reality can create severe financial difficulty for an FI in times of extreme liquidity crises?
Many banks and savings institutions that failed in the 1980s had made loans to oil companies in Louisiana, Texas, and Oklahoma. When oil prices fell, these companies, the regional economy, and the banks and savings institutions all experienced financial problems. What types of risk were inherent in
What is the difference between firm-specific credit risk and systematic credit risk?How can an FI alleviate firm-specific credit risk?
What is credit risk? Which types of FIs are more susceptible to this type of risk?Why?
A bank invested $50 million in a two-year asset paying 10 percent interest per year and simultaneously issued a $50 million, one-year liability paying 8 percent interest per year. The liability will be rolled over after one year at the current market rate. What will be the impact on the bank’s
A money market mutual fund bought $1 million of two-year Treasury notes six months ago. During this time, the value of the securities has increased, but for tax reasons the mutual fund wants to postpone any sale for two more months. What type of risk does the mutual fund face for the next two
If the investment goal is to leave the assets untouched until maturity, such as for a child’s education or for one’s retirement, which of the two bonds has more interest rate risk? What is the source of this risk?
Consider again the two bonds in problem
Two 10-year bonds are being considered for an investment that may have to be liquidated before the maturity of the bonds. The first bond is a 10-year premium bond with a coupon rate higher than its required rate of return, and the second bond is a zero-coupon bond that pays only a lump-sum payment
Corporate bonds usually pay interest semiannually. If a company decided to change from semiannual to annual interest payments, how would this affect the bond’s interest rate risk?
How does a policy of matching the maturities of assets and liabilities work (a)to minimize interest rate risk and (b) against the asset-transformation function of FIs?
What will be the market value of equity for the FI? Assume that all of the NII in part (a) is used to cover operating expenses or dividends.d. If market interest rates had decreased 100 basis points by the end of year 1, would the market value of equity be higher or lower than $1,000? Why?e. What
A financial institution has the following market value balance sheet structure:a. The bond has a 10-year maturity, a fixed-rate coupon of 10 percent paid at the end of each year, and a par value of $10,000. The certificate of deposit has a 1-year maturity and a 6 percent fixed rate of interest. The
Consider an FI that issues $200 million of liabilities with two years to maturity to finance the purchase of $200 million of assets with a one year maturity. Suppose that the cost of funds (liabilities) for the FI is 5 percent per year and the interest return on the assets is 9 percent per year.a.
Consider an FI that issues $100 million of liabilities with one year to maturity to finance the purchase of $100 million of assets with a two-year maturity. Suppose that the cost of funds (liabilities) for the FI is 5 percent per year and the interest return on the assets is 8 percent per year.a.
How can interest rate risk adversely affect the economic or market value of an FI?
The sales literature of a mutual fund claims that the fund has no risk exposure since it invests exclusively in federal government securities which are free of default risk. Is this claim true? Explain why or why not.
What is reinvestment risk? How is reinvestment risk part of interest rate risk?If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest? An increase in the rate of interest?
What is refinancing risk? How is refinancing risk part of interest rate risk? If an FI funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest? A decrease in the rate of interest?
What is the process of asset transformation performed by a financial institution?Why does this process often lead to the creation of interest rate risk? What is interest rate risk?
Go to the Federal Reserve Board’s website at www.federalreserve.gov . From there, click on “Economic Research and Data.” Click on “Flow of Funds Accounts of the United States Releases,” then click on the most recent date.Click on “Level tables.” Go to the table titled “Total
What are the expected annual payments for each instrument?Assume discount rates of 9 percent.d. What is the market value of IOs and POs if the market interest rates for instruments of similar risk decline to 8 percent?
An FI originates a pool of real estate loans worth $20 million with maturities of 10 years and paying interest rates of 9 percent per year.a. What is the average payment received by the FI, including both principal and interest, if no prepayment is expected over the life of the loan?b. If the loans
An FI is planning to issue $100 million in BB rated commercial loans. The FI BB rated will finance the loans by issuing demand deposits.a. What is the minimum amount of capital required under Basel III?b. What is the minimum amount of demand deposits needed to fund this loan assuming there is a 10
Go to the FDIC website at www.fdic.gov. From there, click on “Investors,”then click on “Closed Loan Sales,” and then click on “Find” to get information on recent loan sales by banks. What percentage of the current year’s loan sales consisted of performing versus nonperforming loans?
An FI is planning the purchase of a $5 million loan to raise the existing average duration of its assets from 3.5 years to 5 years. It currently has total assets worth $20 million, $5 million in cash (0 duration) and $15 million in loans. All the loans are fairly priced.a. Assuming it uses the cash
What role did the swap market play in the financial crisis of 2008–09?The following problem refers to material in Appendix 24A.
The bank is a price taker in both the fixed-rate market at 9 percent and the rate-sensitive market at the T-bill rate plus 1.5 percent.A securities dealer has a large portfolio of rate sensitive assets funded with fixed-rate liabilities. The dealer is a price taker in a fixed-rate asset market
Bank A has the following balance sheet information (in millions):Assets Liabilities and Equity Rate-sensitive assets $ 50 Rate-sensitive liabilities $ 75 Fixed-rate assets 150 Fixed-rate liabilities 100 Net worth 25 Total assets $200 Total liabilities and equity $200 Rate-sensitive assets are
A Swiss bank issues a $100 million, three-year Eurodollar CD at a fixed annual rate of 7 percent. The proceeds of the CD are lent to a Swiss company for three years at a fixed rate of 9 percent. The spot exchange rate is SF1.50/$.a. Is this expected to be a profitable transaction?b. What are the
A commercial bank has $200 million of four-year maturity floating-rate loans yielding the T-bill rate plus 2 percent. These loans are financed with $200 million of four-year maturity fixed-rate deposits costing 9 percent. The commercial bank can issue four-year variable-rate deposits at the T-bill
Go to The Wall Street Journal’s website at www.wsj.com. Find the most recent quote for options on U.S. Treasury futures contracts using the following steps.Click on “Market Data,” then under the section titled “COMMODITIES AND FUTURES,” click on “Futures Options.” Click on “INTEREST
Consider Figure 23–13 . What are the prices paid for the following futures option?a. March T-bond calls at $143.00.b. March 10-year T-note puts at $151.50.c. December Eurodollar puts at 99.50 percent.
Calculate the change in the bank’s market value of equity and the change in the value of the T-bond futures position for the bank if interest rates increase by 0.55 percent from the current rate of 6 percent on the T-bond and increase 0.65 percent from the current rate of 8 percent on the balance
Calculate the correct number of futures contracts needed to hedge the bank’s interest rate risk (do not round to the nearest whole contract). Make sure you specify whether you should enter the hedge with a short or long futures position.
Calculate the change in the market value of equity for Bank One if rates increase such thatΔ R /(1 R ) 0.0075.
Using the DGAP model, if interest rates on assets and liabilities increase such that Δ RA /(1 RA ) Δ RL /(1 RL ) 0.0075, calculate the change in the value of assets and liabilities and the new value of the assets and liabilities for Bank One.
Calculate the leverage adjusted duration gap(DGAP) for Bank One.
Go to the Office of the Comptroller of the Currency website at www.occ.treas.gov . Find the most recent levels of futures, forwards, options, swaps, and credit derivatives using the following steps. Click on “Publications.” From there click on “Quarterly Report on Bank Derivatives
Dudley Hill Bank has the following balance sheet:Assets (in millions) Liabilities and Equity (in millions)A $425 L $380 _____ E 45$425 $425 Further,6 years 2 years The bank manager receives information from an economic forecasting unit that interest rates are expected to rise from 8 to 9 percent
An FI is planning to hedge its $100 million bond instruments with a cross hedge using Eurodollar interest rate futures. How would the FI estimate br R R R R [ /(1 ) / /(1 )] f f to determine the exact number of Eurodollar futures contracts to hedge?
How does consideration of basis risk change your answers to problem 21?a. Compute the number of futures contracts required to construct a macrohedge if[ /(1 ) / /(1 )] 0.90 R R R R br f fb. Explain what is meant by br 0.90.c. If br 0.90, what information does this provide on the number
Refer again to problem
Consider the following balance sheet (in millions) for an FI:Assets Liabilities Duration 10 years $950 Duration 2 years $860 Equity 90a. What is the FI’s duration gap?b. What is the FI’s interest rate risk exposure?c. How can the FI use futures and forward contracts to put on a
Reconsider Tree Row Bank in problem 16 but assume that the cost rate on the liabilities is 6 percent. On-balance-sheet rates are expected to increase by 100 basis points. Further, assume there is basis risk such that rates on 3-month Eurodollar CDs are expected to change by 0.10 times the rate
The duration of a 20-year, 8 percent coupon Treasury bond selling at par is 10.292 years. The bond’s interest is paid semiannually, and the bond qualifies for delivery against the Treasury bond futures contract.a. What is the modified duration of this bond?b. What is the impact on the Treasury
Mark to market the position.
What is the loss or gain?d. Assume that the Treasury bond futures price rises to
Suppose an FI purchases a Treasury bond futures contract at 95.a. What is the FI’s obligation at the time the futures contract is purchased?b. If an FI purchases this contract, in what kind of hedge is it engaged?c. Assume that the Treasury bond futures price falls to
The FI would like to hedge against the expected change in interest rates with an appropriate position in a forward contract. What will this position be? Show that if rates rise 1 percent as forecast, the hedge will protect the FI from loss.
An FI holds a 15-year, $10 million par value bond that is priced at 104 with a yield to maturity of 7 percent. The bond has a duration of eight years, and the FI plans to sell it after two months. The FI’s market analyst predicts that interest rates will be 8 percent at the time of the desired
Go to the FDIC website at www.fdic.gov . Find the most recent breakdown of bank holding company deposit share for the State of New York using the following steps. Click on “Analysts.” From there click on “Summary of Deposits”and then click on “Deposit Market Share” Under “State- >
The bank’s various lines of business produced the following gross income:Retail banking $40,000 Commercial banking 50,000 Payment and settlement 15,000 Trading and sales 5,000 Asset management 10,000 What is the add-on to capital for operational risk? Does the bank have sufficient capital to
Disregarding the capital conservation buffer, what is the bank’s capital adequacy level(under Basel III) if the par value of its equity is $225,000, surplus value of equity is $200,000, qualifying perpetual preferred stock is $50,000, subordinated debt is $50,000, and loan loss reserve is
What is the bank’s risk-adjusted asset base under Basel III?
A property–casualty insurance company has estimated the following required charges for its various risk classes (in millions):Risk Description RBC Charge R0 Affiliated P/C $ 2 R1 Fixed income 3 R2 Common stock 4 R3 Reinsurance 3 R4 Loss adjustment expense 2 R5 Written premiums 3 Total $17a. What
A life insurance company has estimated capital requirements for each of the following risk classes: asset risk-affiliate (C0) $2 million, asset risk-other( C1 ) $5 million, insurance risk ( C2 ) $4 million, interest rate risk ( C3 )$1 million, and business risk ( C4 ) $3 million.a. What is the

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