Question 3 (6 marks)

(a) Consider the following information for a bank:

Assets 220mil, duration of 1.397years.

Liabilities 200mil, duration of 0.5535year.

(i) What is the banks leverage-adjusted duration gap? (in years, answer in 4 decimal places)

(ii) Briefly explain the banks interest rate exposure from your calculation in (a).

(iii) If interest rates rise by 1%, what is the new market value of the banks equity? (R=1%) (answer in mil) (3 marks)

(b) A bank is looking to hedge its interest rate risk with a $100mm notional long put option (a FLOOR) of 10%, paying premium of 0.5% of face value.

(i) If interest rate falls to 8%, what is the net profit? (answer in mil)

(ii) What kind of balance sheet should you expect the bank to have when buying this put option as a hedge? (3 marks)