Answer the following question given below:

1. How do monetary policy actions made by the Federal Reserve impact interest rates?

2. 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.

3. What is a maturity bucket in the repricing model? Why is the length of time selected for repricing assets and liabilities important when using the repricing model?

4. 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?

5. 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?

6. 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 = $140 million

a. Calculate the repricing gap and the impact on net interest income of a 1 percent increase in interest rates for each position.

7. 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 savings accounts?

8. Which of the following assets or liabilities fit the one-year rate or repricing sensitivity test?

3-month U.S. Treasury bills
1-year U.S. Treasury notes
20-year U.S. Treasury bonds
20-year floating-rate corporate bonds with annual repricing
30-year floating-rate mortgages with repricing every two years
30-year floating-rate mortgages with repricing every six months
Overnight fed funds
9-month fixed rate CDs
1-year fixed-rate CDs
5-year floating-rate CDs with annual repricing
Common stock

9. What is the spread effect?

10. Consider the following balance sheet for WatchoverU Savings, Inc. (in millions):

Assets Liabilities and Equity
Floating-rate mortgages 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 7% annually) $20
Equity $10
Total assets $100 Total liabilities & equity $100

a. What is WatchoverU's expected net interest income at year-end?

b. What will net interest income be at year-end if interest rates rise by 2 percent?

c. Using the cumulative repricing gap model, what is the expected net interest income for a 2 percent increase in interest rates?

d. What will net interest income be at year-end if interest rates on RSAs increase by 2 percent but interest rates on RSLs increase by 1 percent? Is it reasonable for changes in interest rates on RSAs and RSLs to differ? Why?

11. Use the following information about a hypothetical government security dealer named M.P. Jorgan. Market yields are in parenthesis, and amounts are in millions.

Assets Liabilities and Equity
Cash $10 Overnight repos $170
1-month T-bills (7.05%) 75 Subordinated debt
3-month T-bills (7.25%) 75 7-year fixed rate (8.55%) 150
2-year T-notes (7.50%) 50
8-year T-notes (8.96%) 100
5-year munis (floating rate)
(8.20% reset every 6 months) 25 Equity 15
Total assets $335 Total liabilities & equity $335

a. What is the repricing gap if the planning period is 30 days? 3 months? 2 years? Recall that cash is a non-interest-earning asset.

b. What is the impact over the next 30 days on net interest income if interest rates increase 50 basis points? Decrease 75 basis points?

c. The following one-year runoffs are expected: $10 million for two-year T-notes and $20 million for eight-year T-notes. What is the one-year repricing gap?

d. If runoffs are considered, what is the effect on net interest income at year-end if interest rates increase 50 basis points? Decrease 75 basis points?

12. A bank has the following balance sheet:

Assets Avg. Rate Liabilities/Equity Avg. Rate
Rate sensitive $550,000 7.75% Rate sensitive $375,000 6.25%
Fixed rate 755,000 8.75 Fixed rate 805,000 7.50
Nonearning 265,000 Nonpaying 390,000
Total $1,570,000 Total $1,570,000

Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis points.

a. Calculate the bank's repricing GAP and gap ratio.

b. Assuming the bank does not change the composition of its balance sheet, calculate the resulting change in the bank's interest income, interest expense, and net interest income.

c. Explain how the CGAP and spread effects influenced the change in net interest income.

13. A bank has the following balance sheet:

Assets Avg. Rate Liabilities/Equity Avg. Rate
Rate sensitive $550,000 7.75% Rate sensitive $575,000 6.25%
Fixed rate 755,000 8.75 Fixed rate 605,000 7.50
Nonearning 265,000 Nonpaying 390,000
Total $1,570,000 Total $1,570,000

Suppose interest rates fall such that the average yield on rate-sensitive assets decreases by 15 basis points and the average yield on rate-sensitive liabilities decreases by 5 basis points.

a. Calculate the bank's CGAP and gap ratio.

b. Assuming the bank does not change the composition of its balance sheet, calculate the resulting change in the bank's interest income, interest expense, and net interest income.

c. The bank's CGAP is negative and interest rates decreased, yet net interest income decreased. Explain how the CGAP and spread effects influenced this decrease in net interest income.

14. 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 Liabilities and Equity
Cash $20 Overnight repos $340
1-month T-bills (7.05%) 150 Subordinated debt
3-month T-bills (7.25%) 150 7-year fixed rate (8.55%) 300
2-year T-notes (7.50%) 100
8-year T-notes (8.96%) 200
5-year munis (floating rate)
(8.20% reset every 6 months) 50 Equity 30
Total assets $670 Total liabilities and equity $670

a. What is the repricing gap if the planning period is 30 days? 3 month days? 2 years?

b. What is the impact over the next three months on net interest income if interest rates on RSAs increase 50 basis points and on RSLs increase 60 basis points?
c. What is the impact over the next two years on net interest income if interest rates on RSAs increase 50 basis points and on RSLs increase 60 basis points?

d. Explain the difference in your answers to parts (b) and (c). Why is one answer a negative change in NII, while the other is positive?

15. A bank has the following balance sheet:

Assets Avg. Rate Liabilities/Equity Avg. Rate
Rate sensitive $225,000 6.35% Rate sensitive $300,000 4.25%
Fixed rate 550,000 7.55 Fixed rate 505,000 6.15
Nonearning 120,000 Nonpaying 90,000
Total $895,000 Total $895,000

Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis points.

a. Calculate the bank's repricing GAP.

b. Assuming the bank does not change the composition of its balance sheet, calculate the net interest income for the bank before and after the interest rate changes. What is the resulting change in net interest income?

c. Explain how the CGAP and spread effects influenced this increase in net interest income.

16. What are some of the weakness 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 model's analysis?

17. What is a maturity gap? How can the maturity model be used to immunize an FI's portfolio? What is the critical requirement that allows maturity matching to have some success in immunizing the balance sheet of an FI?

18. Nearby Bank has the following balance sheet (in millions):

Assets Liabilities and Equity
Cash $60 Demand deposits $140
5-year Treasury notes 60 1-year certificates of deposit 160
30-year mortgages 200 Equity 20
Total assets $320 Total liabilities and equity $320

What is the maturity gap for Nearby Bank? Is Nearby Bank more exposed to an increase or decrease in interest rates? Explain why?

19. 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 $20 Demand deposits $100
15-year commercial loan at 10% 5-year CDs at 6% interest,
interest, balloon payment 160 balloon payment 210
30-year mortgages at 8% interest, 20-year debentures at 7% interest, 120
balloon payment 300 balloon payment
Equity 50
Total assets $480 Total liabilities & equity $480

a. What is the maturity gap for County Bank?

b. What will be the maturity gap if the interest rates on all assets and liabilities increase by 1 percent?

c. What will happen to the market value of the equity?

20. If a bank manager is certain that interest rates were going to increase within the next six months, how should the bank manager adjust the bank's maturity gap to take advantage of this anticipated increase? What if the manager believes rates will fall? Would your suggested adjustments be difficult or easy to achieve?

21. 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 & equity $340

All securities are selling at par equal to book value. The two-year notes are yielding 5 percent, and the 15-year munis are yielding 9 percent. The one-year commercial paper pays 4.5 percent, and the five-year notes pay 8 percent. All instruments pay interest annually.

a. What is the weighted-average maturity of the assets for Gunnison?

b. What is the weighted-average maturity of the liabilities for Gunnison?

c. What is the maturity gap for Gunnison?

d. What does your answer to part (c) imply about the interest rate exposure of Gunnison Insurance?

e. Calculate the values of all four securities of Gunnison Insurance's balance sheet assuming that all interest rates increase 2 percent. What is the dollar change in the total asset and total liability values? What is the percentage change in these values?

f. What is the dollar impact on the market value of equity for Gunnison? What is the percentage change in the value of the equity?

g. What would be the impact on Gunnison's market value of equity if the liabilities paid interest semiannually instead of annually?

22. Scandia Bank has issued a one-year, $1million 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? According to the maturity model, what does this maturity gap imply about the interest rate risk exposure faced by Scandia Bank?

b. What is the expected net interest income at the end of the year?

c. What would be the effect on annual net interest income of a 2 percent interest rate increase that occurred immediately after the loan was made? What would be the effect of a 2 percent decrease in rates?

d. What do these results indicate about the ability of the maturity model to immunize portfolios against interest rate exposure?

23. 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 loan and the deposit principal will be paid at maturity.

a. What is the maturity gap of this balance sheet?

b. What is the expected net interest income in year 1 and year 2?

c. Immediately prior to the beginning of year 2, LIBOR rates increased to 6 percent. What is the expected net interest income in year 2? What would be the effect on net interest income of a 2 percent decrease in LIBOR?

24. What are the weaknesses of the maturity model?

25. The current one-year Treasury bill rate is 5.2 percent, and the expected one-year rate 12 months from now is 5.8 percent. According to the unbiased expectations theory, what should be the current rate for a two-year Treasury security?

26. 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, respectively) are as follows:

1R1=6% E(2r1)=7% E(3r1)=7.5% E(4r1)=7.85%

Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. Plot the resulting yield curve.

27. 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 expectations theory, what are the expected one-year rates for years 4, 5, and 6?
28. 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 expect the one-year Treasury rate to be in year 4, E(4r1)?

29. How does the liquidity premium theory of the term structure of interest rates differ from the unbiased expectations theory? In a normal economic environment, that is, an upward- sloping yield curve, what is the relationship of liquidity premiums for successive years into the future? Why?

30. 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:

1R1 = 5.65%

E(2r1) = 6.75% L2 = 0.05%

E(3r1) = 6.85% L3 = 0.10%

E(4r1) = 7.15% L4 = 0.12%

Using the liquidity premium hypothesis, plot the current yield curve. Make sure you label the axes on the graph and identify the four annual rates on the curve both on the axes and on the yield curve itself.

31. 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 year four is E(4r1), 6.10 percent. According to the liquidity premium hypothesis, what is the liquidity premium on the four-year Treasury security, L4?

32. 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, 2f1?

Academic requirements:

• Your work must be submitted as  pages 16 -18 of pages

• Your work should be submitted in the formats outlined for each questionin the assignment.