Bank Management 4th Edition Koch, Timothy W., MacDonald, S. Scott - Solutions

It is important to note that the prevailing futures rate at the time a hedge is initiated reflects consensus information regarding the future level of cash market rates. Explain conceptually why the effectiveness of hedging is influenced by the accuracy of the futures rate.
Suppose instead that interest rates declined after April 9 and the bank actually issued Eurodollars at 6.16 percent. Assuming it closed out its futures position at 6.23 percent, calculate the same profit/loss and return/ cost components as above.
Which Eurodollar futures contract should the bank use? Explain why it is best. Assume that the bank takes the futures position that you recommend in questions 1 and 2 at the rate available on April 9, 1999. On July 8, 1999, the bank issues $10 million in Eurodollars, at 7.10 percent.
What is the bank’s specific cash market risk on April 9, 1999? Should the bank buy or sell Eurodollar futures to hedge its borrowing costs? Explain how the hedge should work.
Your bank is looking for the lowest cost 2-year, fixed-rate financing. It has decided to issue four consecutive 3-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 appropriate? Use
Your firm just made a 3-year fixed-rate loan at 8.25 percent. You would like to convert this to a floating-rate loan that is priced off of 3-month LIBOR as the base rate. Explain how you could use a basic interest rate swap to ac- complish this. Using the data from Exhibit 10.7, choose swap terms
A basic interest rate swap is supposedly priced as a zero net present value transaction. Explain what this means. Use the 2-year swap data from Ex- hibit 10.7 to demonstrate your arguments.
Is there credit risk in an interest rate swap with an intermediary bank serv- ing as the swap dealer. Describe when default losses might arise and which party is at risk. How can credit risk be reduced?
What features of interest rate swaps make them more or less attractive than financial futures as a risk management tool?
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?
It is January 1. Your firm expects to issue (borrow) 3-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 3-month LIBOR if you wanted to fully hedge your future borrowings. Why
Assume that you want to speculate on how 6-month cash market LIBOR will move over the next year. You believe that consensus forecasts of fu- ture rates are too high. You can enter into a FRA and agree either to pay 7.25 percent and receive 6-month LIBOR, or pay 6-month LIBOR and receive 7.25
What are the risks in a forward rate agreement if you are the buyer?
A bank has assets of $10 million earning an average return of 9 percent and with a weighted duration of 1.5 years. It has liabilities of $9 million paying an average rate of 6.5 percent with a weighted duration of 3.5 years. The bank wants to construct a macrohedge to reduce interest rate risk as
Explain how macrohedging differs from microhedging.
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?
Abank plans to hedge using 3-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 6-month CDs in four months. The Eurodollar futures rate moves
Ineach of the following cases, conduct the analysis for Step 1 and Step 2 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 to receive a large, past-due
Explain why cross-hedges generally exhibit greater risk than hedges using a futures contract based on the underlying cash instrument hedged.
Suppose that you are a speculator who tries to time interest rate move- ments on 3-month T-bill futures contracts. Use the data in Exhibit 10.1 and assume that it’s June 29, 1998, to answer the following questions.a. What is the 3-month T-bill rate in the cash market? (Approximate it from the
Suppose that you are a speculator who trades 3-month Eurodollar futures. On November 5 you sell two December 3-month Eurodollar futures con- tracts at 94.81. The subsequent weekly quotes for the closing December Eurodollar futures price are as follows:Date: 11/12 11/19 11/26 12/3 Price: 94.92 95.08
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?
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?
How does a futures contract differ from a forward contract?
Discuss what impact each of the following will have, in general, on MVE 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.
ALCO members are considering the following MVE sensitivity estimates. The figures refer to the percentage change in market value of equity com- pared to the base rate forecast scenario. What does the information say about the bank's overall interest rate risk? Rate Change from Base Case -3% %
Suppose that your bank currently operates with a duration gap of 2.2 years. Which of the following will serve to reduce the bank's interest rate risk?a. Issue a 1-year zero coupon CD to a customer and use the proceeds to buy a 3-year zero coupon Treasury bond.b. Sell $5 million in 1-year bullet
Conduct duration gap analysis using the following information:
Is the following statement generally true or false? Provide your reasoning. "A bank with a negative GAP through three years will have a positive du- ration gap."
Compare the strengths and weaknesses of GAP and earnings sensitivity analysis with DGAP and MVE sensitivity analysis.
Use duration gap 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 5-year maturity that pays 5 percent annual interest compounded daily. All interest and principal are paid at the end of five
A 5-year zero coupon bond and 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.
b. Calculate the bond's effective duration assuming a 50 basis point in- crease or decrease in market rates.
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 re- maining 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
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.a. Calculate the bond’s Macaulay’s duration and modified duration.
Which has a longer Macaulay’s duration: a zero coupon bond with a 2-year maturity, or a 2-year maturity coupon bond that pays 6 percent coupon interest if they both carry a 6 percent market yield? Explain your reasoning.
List the basic steps in duration gap analysis. What is the importance of different interest rate forecasts?
Given the following information for E-Bank, calculate its Income Statement(Effective) GAP. How much will net interest income change if the 1-year Treasury rate falls 1 percent?
Interpret the following earnings-at-risk data. What does it suggest regarding the bank’s risk exposure?
Exhibit 8.9 demonstrates that ABC bank loses in year two if rates either rise or fall sharply from the most likely scenario. Explain why in terms of when embedded options are expected to be exercised and what happens to spreads.
What information is available from earnings sensitivity analysis that is not provided by static GAP analysis?
Each of the following potentially alters the rate-sensitivity of the underly- ing instrument. Presumably there is an embedded option associated with each. Indicate when the option is typically exercised and how it affects rate sensitivity.a. Fixed-rate mortgage loan with a yield of 8 percent and
Management at Bay Bank expects its net interest margin to equal 4.8 percent during the next year. It will allow variation in NIM of just 10 percent during the year and expects interest rates to either rise or fall by 2 percent. If management expects the bank to have $400 million in earning assets,
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 is
Consider the Rate Sensitivity Report in Exhibit 8.6.a. Is Security Bank positioned to profit or lose if interest rates rise over the next 30 days?b. Suppose that management has misstated the rate-sensitivity of the bank's money market deposit accounts because the bank has not changed the rate it
Consider the following asset and liability structures: County Bank Asset: $10 million in a 1-year, fixed-rate commercial loan Liability: $10 million in a 3-month CD City Bank Asset: $10 million in a 3-year, fixed-rate commercial loan Liability: $10 million in a 6-month CDa. Calculate each bank's
Discuss the problems that loans tied to a bank’s base rate present in mea- suring interest rate risk where the base rate is not tied directly to a specific market interest rate.
What is the fundamental weakness of the GAP ratio compared with GAP as a measure of interest rate risk?
Suppose that your bank buys a T-bill that matures in six months and fi- nances the purchase with a 3-month time deposit.a. Calculate the 6-month GAP associated with this transaction. What does this GAP measure indicate about interest rate risk in this transaction?b. Calculate the 3-month GAP
Consider the following bank balance sheet and associated average interest rates. The time frame for rate sensitivity is one year.
(OG) - commercial loan priced at the bank’s prime rate plus 2 percent
Are the following assets rate-sensitive within a six-month time frame?Explain.. 3-month T-bill. federal funds sold. 2-year Treasury bond. 4-year fully amortized car loan with monthly payments@O
List the four basic steps in static GAP analysis. What is the objective of each?
Read your local and state tax rules on Treasury securities and in-state mu- nicipal bond interest. Explain how these taxes should affect municipal bond rates in your state. Should they be higher or lower than rates on comparable municipals issued in other states?
When was the last time the yield curve was inverted? Did a recession follow in the time interval suggested by Exhibit 7.12? If not enough time has lapsed, is a recession due?
Using Treasury bond and note rates from a recent issue of the Wall Street Journal, fill in the following table to generate a yield curve. Maturity 6 months 1 year 2 years 3 years 5 years 15 years Yielda. Based on this data, what will be the 1-year, risk-free rate starting one year from today if you
Although it has a considerably longer maturity, an individual's mortgage usually carries a lower interest rate than his or her car loan. Why?
What would be considered the repricing maturity of the following in- vestments:a. A 10-year corporate bond with a 5 percent coupon rateb. A variable rate mortgage with the rate reset quarterly to the cost of funds of the S&Lc. A floating rate small business loan tied to primed. A 5-year callable
Downward sloping yield curves are somewhat unusual. What theory of the term structure generally supports a bias toward a downward sloping yield curve? Explain. Use this same theory to explain a downward slop- ing yield curve.
Assume that you expect the real rate of interest to remain constant at 2.5 percent over the next several years? Using the data above, what do in- vestors expect to happen to inflation in one year, two years and three years under the Fisher equation?
What is the 1-year forward rate for the period beginning two years from today? Three years from today? What is the 2-year forward rate for the period beginning two years from today?
What is the 1-year forward rate for the period beginning one year from to- day? If you believe the unbiased expectations theory, what does this mean? How does this interpretation change if you believe the liquidity premium theory? The market segmentation theory?
One of the biggest advantages to a firm from issuing convertible bonds rather than stock is that bondholders are paid a fixed rate of return. If the firm does well, existing shareholders do not have to pay bondholders more than the fixed return they agreed to pay. If the firm does poorly, they
If the highest marginal individual tax rate is 39 percent, and the highest cor- porate rate is 34 percent, which group will get the greatest benefit from holding municipal securities as investments?
Your city government has decided to issue tax-exempt revenue bonds to finance the building of a new sports stadium. What interest rate will it have to pay if taxable bonds of comparable risk are paying 7 per- cent and the marginal tax rate of marginal investors in the bonds is 31 percent?
Which one from each of the following pairs is likely to have higher default risk? Explain your reasoning.a. A six-month loan or a five-year loan to the same companyb. A loan requiring periodic payments or a loan with all principal and in- terest due at the end (balloon loan)c. A loan to a company
Discuss how the loanable funds theory would explain rising interest rates during the expansion phase, then the contractionary phase, of the business cycle. Would the supply and/or the demand curve be shifting?
At what point in the business cycle is the yield curve expected to be the steepest? When is it expected to be flat and at what point in the business cycle would you expect the yield curve to slope downward? Explain. What relationship between the yield curve and the business cycle can explain this
The Fisher Relation is based upon expectations of inflation and not actual inflation. Why? How often do the two differ? Can ex ante real rates be negative? Can ex post real rates be negative?
Assume that the Fisher Relation is correct such that a 2 percent increase in expected inflation would mean that the nominal rate of interest increased by exactly 2 percent. Darby-Feldstein would argue that the nominal rate of interest would have to increase by more than 2 percent. If the nominal
The major argument surrounding the Fisher Relation deals with the relationship between the real rate and expected inflation. What would each of Fisher, Mundell-Tobin, and Darby-Feldstein claim that relationship to be and what is the implication of each position? What is the difference between the
Assume the Fisher Relation is correct and you believe that the real rate of interest is a constant 2.5 percent. If you think that inflation will be 3 percent in the upcoming year and 4 percent in the following year, what minimal rate of interest would entice you to lend money for a year? Would you
According to the Fisher Relation, what causes nominal market interest rates to be volatile? How long does it take before participants change inflation expectations? ‘
Indicate whether the following changes in the interest rate are caused by a shift in the loanable funds demand curve (DF) or a shift in the supply curve (SF). Draw a graph to show each effect. Indicate whether interest rates will rise or fall.a. There is a major business expansion in the economy.b.
Indicate which of the following would be a portion of the supply of loanable funds (SF) and which would be a portion of the demand (DF) for loanable funds.a. You put $500 of your paycheck into your savings account.b. The local McDonald’s makes a regular deposit into its demand deposit account
Use the Loanable Funds Theory to explain what would happen to the supply or demand for loanable funds if a majority of people decided they no longer need to carry cash and instead deposited all of their pocket cash into checking accounts and just used debit cards. Graphically plot what would
Locate the first General Electric (GE) corporate bond maturing after the year 2000 as reported in the Wall Street Journal. What is its coupon rate, maturity, and stream of coupon and principal payments? At the rate of return earned most recently on the DJ 20 Bond Index, what price would you be
Rates for the most popular financial instruments can be found in the Wall Street Journal. Collect the rates for the following securities. This information can be found on the front of the “Money and Investing” section and inside in the “Credit Markets” column.3-month T-bill 3-month
You buy 100 shares in Bondex Corp. for $25 a share. Each share pays $1 in dividends every three months. You have a five-year holding period and ex- pect to invest all dividends received in the first two years at 6 percent, and all dividends received the next three years at 9 percent. Calculate your
You are planning to buy a corporate bond with a 7-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 5-year bond is priced to yield 7.2 percent annually to maturity. Assuming that you
You have just purchased a 5-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 semiannually).
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 $9,620. What is the dis- count rate on this security? What is its bond equivalent yield?
For which money market instruments are rates calculated based on par value rather than purchase price?
What is the bond equivalent yield of a 180-day, $1 million face value Trea- sury bill with a discount rate of 4.5 percent?
Which money market instruments are typically quoted on a discount basis?
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 present value formula and Equation 6.14. How does this conclusion
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 semi- annual compounding. Now use the present value formula to determine the
One author says that duration is the weighted average life of a financial in- strument. A different one says that duration is a measure of elasticity. Which of the authors is correct? Or, are they both correct?
Lamar Briggs purchased a 7 percent coupon corporate bond that matured in 10 years and paid interest semiannually. He paid $2,800 and six months later, immediately following an interest payment, he sold the bond. At the time of sale, the market interest rate on bonds of this type was 6 percent. What
A Treasury security carries a fixed 6 percent annual coupon rate and ma- tures in exactly two years. The Treasury is currently priced at $10,000 par value to yield 6 percent to maturity. Assume that you can buy the bond and strip the coupons and final principal payment and sell each of them as a
Consider a 7 percent coupon U.S. Treasury note that has a $10,000 face value and matures 10 years from today. This note pays interest semiannu- ally. The current market interest rate on this bond is 6 percent. Would you expect the bond to be a discount, premium, or par bond? Calculate the ac- tual
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 12 percent compounded monthly. You have nothing to trade and no down payment. The most expensive car you can purchase is: 1) an old
Three local banks pay different interest rates on time deposits with oneyear maturities. Rank the three banks from highest to lowest in terms of the depositor’s return.Bank 1—4.5 percent per year compounded annually Bank 2—4.3 percent per year compounded quarterly Bank 3—4.1 percent per
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?
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?
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?
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?
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 effective interest rate of 10 percent compounded quarterly, versus 10 percent compounded monthly?
If you invest $20,000 in a security today, how much will it be worth in six years? The security pays 6 percent compounded monthly.

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Bank Management 4th Edition Koch, Timothy W., MacDonald, S. Scott - Solutions

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