Types of Risks Facing Financial Institutions
HW #3 – Types of Risks Facing Financial Institutions
This homework assignment is worth up to 20 points toward your final grade.
- Suppose a bank has the following assets and liabilities on its balance sheet:
Loans $100 million 3.75% 5 years
CDs $100 million 3.15% 3 years
All rates are locked in for the period of time specified.
- Is the bank long-funded or short-funded? What types of interest rate risk is the bank exposed to? Explain. (2 points)
- What is the bank’s spread? (2 points)
- If interest rates are expected to rise by 0.5% in Year 3, what will happen to the bank’s spread? (3 points)
- If interest rates are expected to decline by 0.25% in Year 3, what will happen to the bank’s spread? (3 points)
- The Bank made a $750,000 loan (in £). The terms of the loan require annual interest payments at 2.50% per year, to be fully repaid in two years (June 2020). At the time the loan was made the US dollar was worth £0.833. The bank funded the loan with $750,000 certificate of deposits with a 1-year term and rate of 1.75%.
- What is the Direct Quote? (2 points)
- Is the transaction short-funded or long-funded? Explain. (2 points)
- When the loan matures in two years the anticipated exchange rate is £1.00 = $1.33. Calculate the Net Interest Income at the end of Year 2, assuming interest rates do not change. (6 points)