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.

 

  1. 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.

  1. Is the bank long-funded or short-funded? What types of interest rate risk is the bank exposed to? Explain. (2 points)

 

 

  1. What is the bank’s spread? (2 points)

 

 

  1. If interest rates are expected to rise by 0.5% in Year 3, what will happen to the bank’s spread? (3 points)

 

  1. If interest rates are expected to decline by 0.25% in Year 3, what will happen to the bank’s spread? (3 points)

 

  1. 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%.

 

  1. What is the Direct Quote? (2 points)

 

  1. Is the transaction short-funded or long-funded? Explain. (2 points)

 

 

  1. 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)

 

 

 

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