Banking in the modern world Homework 2 - Essay Example

What is the leverage-adjusted duration gap? Total value of portfolios of Assets = Commercial Loan + Consumer Loan = $400 + $250 = $650 Fractional value of assets at = 61.5 = 0.615% Fractional value of assets B = 38.4 = 0.384% Weighted Average Duration= Duration asset A (% in portfolio) + Duration of asset B (% in portfolio) Weighted Average Duration= 3 years (. 615) + 7 years (. 384) Weighted Average Duration= 1.85 + 2.69 = 4.54 years Total value of portfolios of Liability = IG Bonds + Deposits + Non-deposit borrowing = $65 + $600 + $50= $715 Fractional value of Liability A = .

091 Fractional value of Liability B = .839 Fractional value of Liability C = .070 Weighted Average Duration= Duration Liability A (% in portfolio) + Duration of Liability B (% in portfolio) + Duration Liability C (% in portfolio) Weighted Average Duration= 15 years (.091) + 1.25 years (.839) + .50 years (.070) Weighted Average Duration= 1.365 + 1.049 + .035 Weighted Average Duration= 2.4 years Leverage-adjusted duration gap is a formula that measures the overall interest rate of bank and it tells positive or negative changes in the overall interest rate of a banking company. B. What is going to happen to the Bank’s net worth if interest rates will increase or decrease by 1 per cent from the current 5 percent?

Interpret the results. Each banking service provider has to face the interest rate risk in its business and if the market rate increases or decrease, it affects the value of cash of banks. Suppose market rate increases with 1 %, then the demand and value of cash will not be affected and it will remain un-changed. But the value of the loan will effect and it will decrease. In this case, the market value of equity of that bank will increase and thus investors will get another opportunity to invest. C. How the Bank can reduce its exposure to interest rate risk?

Show this with a numerical example. Each bank has an option to alter its interest rate exposure by making some changes and restricting its investment plans, borrowings and other pricing strategies and this can be done with the help of managing maturity times of its current portfolio. Question No. 2. What kind of futures or options hedges would be called for in the following situations? a. Market interest rates are expected to increase and your financial firm’s asset-liability managers expect to liquidate a portion of their bond portfolio to meet customers’ demands for funds in the upcoming quarter.

Usually Financial firms expect a lower price for selling their bond portfolio in the market but they don’t expect it if the portfolio consists on short future hedge securities. After selling them on lower prices, they use to repurchase them at a profit giving rate. A similar profit can be made by the bank with the help of Put options for government and financial futures contracts. b. Your financial firm has interest-sensitive assets of $79 million and interest-sensitive liabilities of $88 million over the next 30 days and market interest rates are expected to rise.

Financial firm has increased its interest-sensitive assets by $9 million that means this firm is a growing yo bear looser if the interest rate in the market increases. This firm need to hedge its risk it's going to bear on increased $9 million and for this, it should sell financial futures contracts or use a put option on government securities or financial futures contracts. c. A survey of Tuskee Bank’