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financial institutions management
Financial Institutions Management A Risk Management Approach 11th International Edition Anthony Saunders, Marcia Millon Cornett, Otgo Erhemjamts - Solutions
= Metrobank offers one-year loans with a 9 percent stated or base rate, charges a 0.25 percent loan origination fee, imposes a 10 percent compensating balance requirement, and must pay a 6 percent reserve requirement to the Federal Reserve. The loans typically are repaid at maturity. If the risk
= What are compensating balances? What is the relationship between the amount of compensating balance requirement and the return on the loan to the FI?
= How does the credit card transaction process assist in the credit monitoring function of financial institutions? Which major parties receive a fee in a typical credit card transaction? Do the services provided warrant the payment of these associated fees?
= What are the two major classes of consumer loans at U.S. banks? How do revolving loans differ from nonrevolving loans?
= What are the primary characteristics of residential mortgage loans? Why does the ratio of adjustable rate mortgages to fixed-rate mortgages in the economy vary over the interest rate cycle? When would the ratio be highest?
= Differentiate between a secured loan and an unsecured loan. Who bears most of the risk in a fixed-rate loan? Why would FI managers prefer to charge floating rates, especially for longer-maturity loans?
MLK Bank has an asset portfolio that consists of $100 million of 30-year, 8 percent coupon $1,000 bonds that sell at par. What will be the bonds’ new prices if market yields change immediately by +/ − 0.10 percent? What will be the new prices if market yields change immediately by +/ − 2.00
Consider a $1,000 bond with a fixed-rate 10 percent annual coupon rate and a maturity (N) of 10 years. The bond currently is trading to a market yield to maturity (YTM) of 10 percent.a. Complete the following table: Change N Coupon Rate $ Change in Price % Change in YTM Price from Par Price from
Consider a five-year, 15 percent annual coupon bond with a face value of $1,000. The bond is trading at a market yield to maturity of 12 percent.a. What is the price of the bond?b. If the yield to maturity increases 1 percent, what will be the bond's new price?c. Using your answers to parts (a) and
A financial institution has an investment horizon of two years 9.5 months (or 2.7917 years). The institution has converted all assets into a portfolio of 8 percent, $1,000 three-year bonds that are trading at a yield to maturity of 10 percent. The bonds pay interest annually. The portfolio manager
Assume that a goal of the regulatory agencies of financial institutions is to im- munize the ratio of equity to total assets, that is, A(E/A) =0.Explain how this goal changes the desired duration gap for the institution. Why does this differ from the duration gap necessary to immunize the total
Hands Insurance Company issued a $90 million, one-year zero-coupon note at 8 percent add-on annual interest (paying one coupon at the end of the year) or with an 8 percent yield. The proceeds were used to fund a $100 million, two- year commercial loan with a 10 percent coupon rate and a 10 percent
The balance sheet for Gotbucks Bank, Inc. (GBI), is presented below ($ millions). Cash Federal funds Assets Liabilities and Equity $ 30 Core deposits 20 Federal funds 105 Euro CDs 65 Equity $220 Total liabilities and equity Loans (floating) Loans (fixed) Total assets $ 20 50 130 20 $220 Notes to
Two banks are being examined by the regulators to determine the interest rate sensitivity of their balance sheets. Bank A has assets composed solely of a 10-year $1 million loan with a coupon rate and yield of 12 percent. The loan is financed with a 10-year $1 million CD with a coupon rate and
Consider the case in which an investor holds a bond for a period of time lon- ger than the duration of the bond, that is, longer than the original investment horizon.a. If interest rates rise, will the return that is earned exceed or fall short of the original required rate of return? Explain.b.
The duration of an 11-year, $1,000 Treasury bond paying a 10 percent semian- nual coupon and selling at par has been estimated at 6.9 years.a. What is the modified duration of the bond?b. What will be the estimated price change on the bond if interest rates in- crease 0.10 percent (10 basis
You can obtain a loan for $100,000 at a rate of 10 percent for two years. You have a choice of paying the principal at the end of the second year or amortizing the loan, that is, paying interest (10 percent) and principal in equal payments each year. The loan is priced at par.a. What is the
Two bonds are available for purchase in the financial markets. The first bond is a two-year, $1,000 bond that pays an annual coupon of 10 percent. The sec- ond bond is a two-year, $1,000 zero-coupon bond.a. What is the duration of the coupon bond if the current yield to maturity (YTM) is 8 percent?
What is the impact over the next year on net in- terest income if interest rates on RSAs increase 60 basis points and on RSLs increase 40 basis points?
What is the impact over the next six months on net interest income if interest rates on RSAs in- crease 60 basis points and on RSLs increase 40 basis points?
What is the repricing gap if the planning pe- riod is 30 days? 6 months? 1 year? 2 years? 5 years?
You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning two years from today, f? Maturity One day Yield 2.00% One year 5.50 Two years 6.50 Three years 9.00
The Wall Street Journal reports that the rate on three-year Treasury securities is 5.25 percent and the rate on four-year Treasury securities is 5.50 percent. The one-year interest rate expected in three years is E(1), 6.10 percent. According to the liquidity premium hypothesis, what is the
Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows: R = 5.65% E(21) = 6.75% L = 0.05% = E(31) = 6.85% L3 0.10% E() = 7.15% LA = 0.12% Using the liquidity premium hypothesis, plot the current yield
The Wall Street Journal reports that the rate on three-year Treasury securities is 5.60 percent and the rate on four-year Treasury securities is 5.65 percent. According to the unbiased expectations hypothesis, what does the market ex- pect the one-year Treasury rate to be three years from today,
A recent edition of The Wall Street Journal reported interest rates of 6 percent, 6.35 percent, 6.65 percent, and 6.75 percent for three-year, four-year, five-year, and six-year Treasury notes, respectively. According to the unbiased expecta- tions theory, what are the expected one-year rates for
Suppose that the current one-year rate (one-year spot rate) and expected one- year T-bill rates over the following three years (i.e., years 2, 3, and 4, respec- tively) are as follows: R =6% E(2) = 7% E() = 7.5% E() = 7.85% Using the unbiased expectations theory, calculate the current (long-term)
What are the weaknesses of the maturity model? The following questions and problems are based on material in Appendix 8B to the chapter.
EDF Bank has a very simple balance sheet. Assets consist of a two-year, $1 million loan that pays an interest rate of LIBOR plus 4 percent annually. The loan is funded with a two-year deposit on which the bank pays LIBOR plus 3.5 percent interest annually. LIBOR currently is 4 percent, and both the
Scandia Bank has issued a one-year, $1 million CD paying 5.75 percent to fund a one-year loan paying an interest rate of 6 percent. The principal of the loan will be paid in two installments: $500,000 in six months and the balance at the end of the year.a. What is the maturity gap of Scandia Bank?
Gunnison Insurance has reported the following balance sheet (in thousands): Assets Liabilities and Equity 2-year Treasury note $175 1-year commercial paper $135 15-year munis 165 5-year note 160 Equity 45 Total assets $340 Total liabilities and equity $340 All securities are selling at par equal to
The following is a simplified FI balance sheet: Assets Liabilities and Equity Loans $1,000 Deposits Equity $ 850 150 Total assets $1,000 Total liabilities and equity $1,000 The average maturity of loans is four years, and the average maturity of de- posits is two years. Assume that loan and deposit
An insurance company has invested in the following fixed-income securities: (a) $10,000,000 of five-year Treasury notes paying 5 percent interest and selling at par value, (b) $5,800,000 of 10-year bonds paying 7 percent interest with a par value of $6,000,000, and (c) $6,200,000 of 20-year
FI International holds seven-year Acme International bonds and two-year Beta Corporation bonds. The Acme bonds are yielding 12 percent and the Beta bonds are yielding 14 percent under current market conditions.a. What is the weighted-average maturity of FI's bond portfolio if 40 percent is in Acme
Consumer Bank has $20 million in cash and a $180 million loan portfolio. The assets are funded with demand deposits of $18 million, a $162 million CD, and $20 million in equity. The loan portfolio has a maturity of two years, earns in- terest at an annual rate of 7 percent, and is amortized
If a bank manager is certain that interest rates are going to increase within the next six months, how should the bank manager adjust the bank's matu- rity gap to take advantage of this anticipated increase? What if the manager believed rates would fall? Would your suggested adjustments be
County Bank has the following market value balance sheet (in millions, all interest at annual rates). All securities are selling at par equal to book value. Assets Liabilities and Equity Cash 15-year commercial loan $ 20 Demand deposits $100 5-year CDs at at 10% interest, 6% interest, balloon
Nearby Bank has the following balance sheet (in millions): Cash 5-year Treasury notes 30-year mortgages Total assets Assets Liabilities and Equity $ 60 Demand deposits $140 60 200 1-year certificates of deposit Equity 160 20 $320 Total liabilities and equity $320 What is the maturity gap for Nearby
What are some of the weaknesses of the repricing model? How have large banks solved the problem of choosing the optimal time period for repricing? What is runoff cash flow, and how does this amount affect the repricing mod- el's analysis? The following questions and problems are based on material
A bank has the following balance sheet: Assets Rate sensitive $225,000 Avg. Rate 6.35% Liabilities/Equity Rate sensitive $300,000 Avg. Rate 4.25% Fixed rate 550,000 7.55 Nonearning Total 120,000 $895,000 Fixed rate Nonpaying Total 505,000 6.15 90,000 $895,000 Suppose interest rates rise such that
The balance sheet of A. G. Fredwards, a government security dealer, is listed below. Market yields are in parentheses, and amounts are in millions. Assets Cash Liabilities and Equity $ 20 Overnight repos $340 1-month T-bills (7.05%) 150 Subordinated debt 3-month T-bills (7.25%) 150 7-year fixed
A bank has the following balance sheet: Assets Avg. Rate Liabilities/Equity Rate sensitive $ 550,000 7.75% Rate sensitive $ 575,000 Avg. Rate 6.25% Fixed rate Nonearning 755,000 265,000 8.75 Fixed rate Nonpaying 605,000 390,000 7.50 Total $1,570,000 Total $1,570,000 Suppose interest rates fall such
A bank has the following balance sheet: Assets Rate sensitive $ 550,000 Avg. Rate 7.75% Liabilities/Equity Fixed rate Nonearning Total 755,000 265,000 8.75 Rate sensitive Fixed rate $ 375,000 Avg. Rate 6.25% Nonpaying 805,000 390,000 7.50 $1,570,000 Total $1,570,000 Suppose interest rates fall such
Use the following information about a hypothetical government security dealer named M. P. Jorgan. Market yields are in parentheses, and amounts are in millions. Assets Liabilities and Equity Cash $ 10 Overnight repos $170 1-month T-bills (7.05%) 75 Subordinated debt 150 3-month T-bills (7.25%) 75
Consider the following balance sheet for WatchoverU Savings, Inc. (in millions): Floating-rate mortgages Liabilities and Equity Assets 1-year time deposits (currently 10% annually) $ 50 (currently 6% annually) $ 70 30-year fixed-rate loans 3-year time deposits (currently 7% annually) 50 (currently
A bank manager is quite certain that interest rates are going to fall within the next six months. How should the bank manager adjust the bank's six-month repricing gap and spread to take advantage of this anticipated rise? What if the manger believed rates would rise in the next six months.
What is the gap ratio? What is the value of this ratio to interest rate risk man- agers and regulators?
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 = $150 million Rate-sensitive liabilities =
If a bank manager was quite certain that interest rates were going to rise within the next six months, how should the bank manager adjust the bank's six-month repricing gap to take advantage of this anticipated rise? What if the manager believed rates would fall in the next six months.
How do the supply of and demand for loanable funds, together, determine in- terest rates?
What is liquidity risk? What routine operating factors allow Fls to deal with this risk in times of normal economic activity? What market reality can create severe financial difficulty for an FI in times of extreme liquidity crises?
Suppose you purchase a 10-year, AAA-rated Swiss bond for par that is paying an annual coupon of 6 percent. The bond has a face value of 1,000 Swiss francs (SF). The spot rate at the time of purchase is SF1.50/$. At the end of the year, the bond is downgraded to AA and the yield increases to 8
Six months ago, Qualitybank, LTD., issued a $100 million, one-year maturity CD denominated in euros. On the same date, $60 million was invested in a -denominated loan and $40 million was invested in a U.S. Treasury bill. The exchange rate on this date was 1.7382/$. Assume no repayment of principal
Assume that a bank has assets located in London that are worth 150 million on which it earns an average of 8 percent per year. The bank has 100 million in liabilities on which it pays an average of 6 percent per year. The current spot exchange rate is 1.50/$.a. If the exchange rate at the end of
A U.S. insurance company invests $1,000,000 in a private placement of British bonds. Each bond pays 300 in interest per year for 20 years. If the current exchange rate is 1.7612/$, what is the nature of the insurance company's ex- change rate risk? Specifically, what type of exchange rate movement
If international capital markets are well integrated and operate efficiently, will Fls be exposed to foreign exchange risk? What are the sources of foreign exchange risk for Fls?
What two factors provide potential benefits to Fls that expand their asset hold- ings and liability funding sources beyond their domestic borders?
What is credit risk? Which types of Fls are more susceptible to this type of risk? Why?
A bank invested $50 million in a two-year asset paying 10 percent interest per annum and simultaneously issued a $50 million, one-year liability paying 8 percent interest per annum. The liability will be rolled over after one year at the current market rate. What will be the impact on the bank's
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
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 Fls?
A financial institution has the following market value balance sheet structure: Assets Liabilities and Equity Cash Bond $ 1,000 Certificate of deposit 10,000 Equity $10,000 1,000 Total assets $ 11,000 Total liabilities and equity $11,000a. The bond has a 10-year maturity, a fixed-rate coupon of 10
Go to the Standard & Poor's Market Insight Web site at www.mhhe.com/edu- marketinsight and look up the most recent balance sheets for Merrill Lynch (MER) and Morgan Stanley Dean Witter (MWD) using the following steps. Click on "Educational Version of Market Insight." Enter your site ID and click on
Go to the Standard & Poor's Market Insight Web site at www.mhhe.com/ edumarketinsight and look up the industry financial highlights as posted by S&P for investment banking and brokerage using the following steps. Click on "Educational Version of Market Insight." Enter your site ID and click on
Go to the Standard & Poor's Market Insight Web site at www.mhhe.com/ edumarketinsight and identify the industry description and industry con- stituents for investment banking and brokerage using the following steps. Click on "Educational Version of Market Insight." Enter your site ID and click on
Go to the U.S. Treasury Web site at www.ustreas.gov and find the most recent data on foreign transactions in U.S. securities and U.S. transactions in foreign securities using the following steps. Click on "Bureaus." Click on "Financial Management Services (FMS)." Under "Publications", click on
Go to the Thomson Financial Securities Data Web site at www.thomson.com /solutions/financials and find the most recent data on merger and acquisition volume and number of deals using the following steps. Under "xx Quarter League Tables," click on "VIEW NOW." Click on "Mergers & Acquisitions." Click
Based on the data in Table 4-6, what were the second-largest single asset and the largest single liability of securities firms in 2006? Are these asset and liabil- ity categories related? Exactly how does a repurchase agreement work?
How do the operating activities, and thus the balance sheet structures, of secu- rities firms differ from the operating activities of depository institutions such as commercial banks and insurance firms? How are the balance sheet struc- tures of securities firms similar to those of other financial
Using Table 4-5, which type of security accounts for most underwriting in the United States? Which is likely to be more costly to underwrite: corporate debt or equity? Why?
An investor notices that an ounce of gold is priced at $318 in London and $325 in New York.a. What action could the investor take to try to profit from the price discrepancy?b. Under which of the four trading activities would this action be classified?c. If the investor is correct in identifying
XYZ, Inc., has issued 10 million new shares of stock. An investment banker agrees to underwrite these shares on a best-efforts basis. The investment banker is able to sell 8 million shares for $27 per share, and it charges XYZ $0.675 per share sold. How much money does XYZ receive? What is the
An investment banker pays $23.50 per share for 4 million shares of JCN Company. It then sells those shares to the public for $25 per share. How much money does JCN receive? What is the profit to the investment banker? What is the stock price of JCN?
An investment banker agrees to underwrite a $500 million, 10-year, 8 percent semiannual bond issue for KDO Corporation on a firm commitment basis. The investment banker pays KDO on Thursday and plans to begin a public sale on Friday. What type of interest rate movement does the investment bank fear
What are the risk implications to an investment banker from underwriting on a best-efforts basis versus a firm commitment basis? If you operated a com- pany issuing stock for the first time, which type of underwriting would you prefer? Why? What factors might cause you to choose the alternative?
Go to the Investment Company Institute Web site and look up the most re- cent data on the asset values and number of short-term and long-term mutual funds using the following steps. The Web site is www.ici.org. Under "Statistics & Research," click on "Mutual Fund Statistics." Click on "Mutual Fund
Go to the Fidelity Investments Web site and look up the annual 1-, 5-, and 10- year returns on Fidelity Select Biotechnology Fund using the following steps. The Web site is www.fidelity.com. Click on "Investment Products." Click on "Mutual Funds." Click on "Fidelity Mutual Funds." Click on "Browse
What types of fees do mutual funds charge?
What is a 12b-1 fee? Suppose you have a choice between a load fund with no annual 12b-1 fee and a no-load fund with a maximum 12b-1 fee. How would the length of your expected investment horizon, or holding period, influence your choice between these two funds?
What is the difference between a load fund and a no-load fund? Is the argu- ment that load funds are more closely managed and therefore have higher returns supported by the evidence presented in Table 5-7?
Open-end fund A owns 100 shares of AT&T valued at $100 each and 50 shares of Toro valued at $50 each. Closed-end fund B owns 75 shares of AT&T and 100 shares of Toro. Each fund has 100 shares of stock outstanding.a. What are the NAVs of both funds using these prices?b. Assume that in one month the
A mutual fund owns 400 shares of Fiat, Inc., currently trading at $7, and 400 shares of Microsoft, Inc., currently trading at $70. The fund has 100 shares outstanding.a. What is the net asset value (NAV) of the fund?b. If investors expect the price of Fiat shares to increase to $9 and the price of
What change in regulatory guidelines occurred in 1998 that had the primary purpose of giving investors a better understanding of the risks and objectives of a fund?
Why did the proportion of equities in long-term funds increase from 38.3 per- cent in 1990 to over 70 percent by 2000 and then decrease to 62 percent in 2002? How might an investor's preference for a mutual funds objective change over time?
Using the data in Table 5-3, discuss the growth and ownership holding over the last 26 years of long-term funds versus short-term funds.
What are long-term mutual funds? In what assets do these funds usually in- vest? What factors caused the strong growth in this type of fund during the 1990s and early 2000s?
What is a mutual fund? In what sense is it a financial intermediary?
Go to the Standard & Poor's Market Insight Web site at www.mhhe.com/edu- marketinsight and find the most recent balance sheets for Allstate Corporation (ALL) and Cigna (CI) using the following steps. Click on "Educational Version of Market Insight." Enter your site ID and click on "Login." Click on
Go to the Standard & Poor's Market Insight Web site at www.mhhe.com/ edumarketinsight and identify the industry description and industry con- stituents for life and health insurance and property-casualty insurance using the following steps. Click on "Educational Version of Market Insight." Enter
Go to the Insurance Information Institute's Web site at www.iii.org and use the following steps to find the most recent data on the largest life insurance companies by total revenue. Click on "Facts and Statistics." Click on "Financial Services." Click on "www.financialservicesfacts.org." Click on
Go to the FDIC Web site at www.federalreserve.gov and find the most recent distribution of life insurance industry assets for Table 3-2. Click on "Economic Research and Data." Click on "Statistics: Releases and Historical Data." Click on "Flow of Fund Accounts of the United States," "Releases."
Consider the data in Table 3-6. Since 1980, what has been the necessary invest- ment yield for the industry to enable the operating ratio to be less than 100 in each year? How is this requirement related to the interest rate risk and credit risk faced by a property-casualty insurer?
How do state guarantee funds for life insurance companies compare with deposit insurance for commercial banks and thrifts?
Using the data in Table 3-2, how has the composition of assets of U.S. life insurance companies changed over time?
Contrast the balance sheet of a life insurance company with the balance sheet of a commercial bank and with that of a savings institution. Explain the balance sheet differences in terms of the differences in the primary functions of the three organizations.
You deposit $10,000 annually into a life insurance fund for the next 10 years, after which time you plan to retire.a. If the deposits are made at the beginning of the year and earn an interest rate of 8 percent, what will be the amount of retirement funds at the end of year 10?b. Instead of a lump
a. Calculate the annual cash flows of a $1 million, 20-year fixed-payment annu- ity earning a guaranteed 10 percent per year if payments are to begin at the end of the current year.b. Calculate the annual cash flows of a $1 million, 20-year fixed-payment annuity earning a guaranteed 10 percent per
Bank of Bentley has determined that its inventory of yen (¥) and Swiss franc (SFr) denominated securities is subject to market risk. The spot exchange rates are ¥120.00/$ and SFr0.9500/$, respectively. The σ’s of the spot exchange rates of the ¥ and SFr, based on the daily changes of spot
What is the difference between loans sold with recourse and loans sold without recourse from the perspective of both sellers and buyers?
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