Question

2. Use the following information to conduct a duration gap analysis. Assets Amount Rate Duration Cash $ 23,000 0% Bonds $102,000 7.2% 1.8 years Loans $375,000 11.0% 1.5 years Liabilities and Equity Small time deposits $130,000 3.6% 4 years Large CDs $ 70,000 6.3% | 1 year Interest checking $250,000 2.8% 3.3 years Equity $50,000 Calculate the leverage adjusted duration gap. Is the bank positioned to gain or lose money if interest rates rise? Estimate the change in market value of equity if all markets interest rates fall by an average of 1.5%. Note that the rates are provided so that you can calculate “R” in the equation. As is commonly done, use the weighted average of asset yields as R (the average yield). Do you understand what I mean? If not, ask. Suggest a specific transaction the bank could implement to reduce its interest rate risk. a.

Answer 1

a. Leverage adjusted duration gap is 1.582529. That is present value of assets+cash - present value of liabilities divided by equity .

In case interest rate rise bank will loss , because bank assets are giving less interest in less duration in comparison to liabilities interest need to pay by bank .Due to more duration for liabilities there is less impact on interest rise in comparison to assets

B.$89875.08065. We need to calculate the value of all assets adjusted to new interest rates - value of all liabilities adjusted to new interest rates in order to find equity market value . We can calculate this as value of assets(1+ new rate of interest) adjusted to time .

C. Bank can invest in the large durations funds or increase it's cash in the books . By investment in large time durations funds as this will decrease due time value of money .