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Chapter+07+Answers+to+end-of-chapter+questions

# Chapter+07+Answers+to+end-of-chapter+questions - CHAPTER 7...

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CHAPTER 7 INTEREST RATE RISK: THE REPRICING MODEL Chapter outline The Repricing Model Rate-Sensitive Assets Rate-Sensitive Liabilities Weaknesses of the Repricing Model Market Value Effects Over-Aggregation The Problem of Runoffs Instructor’s Resource Manual t/a Financial Institutions Management 2e by Lange, Saunders, Anderson, Thomson & Cornett 1

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Answers to end-of-chapter questions QUESTIONS AND PROBLEMS 1. (a) The repricing model requires specification of the length of the repricing period. Why must a time period be specified? How does the choice of the repricing period impact on the delineation between rate-sensitive and fixed-rate assets and liabilities? (b) What determines the optimal length of the repricing period? What are the shortcomings of very short repricing periods? (c) What are the shortcomings of very long repricing periods? Solutions (a) The length of time over which the repricing gap is to be estimated must be specified in order to define rate-sensitive assets and liabilities. The length of the repricing period determines whether a financial security is either rate- sensitive or fixed rate. The longer the repricing period, the more securities either mature or reprice and therefore the more securities are classified as rate sensitive. (b) An excessively short repricing period omits consideration of the interest rate risk exposure of assets and liabilities that reprice in the period immediately following the end of the repricing period. That is, it understates the rate sensitivity of the balance sheet. (c) An excessively long repricing period includes many securities that are repriced at different times within the repricing period, thereby overstating the rate sensitivity of the balance sheet. 2. Calculate the repricing gap and impact on net interest income of a 1 per cent increase in interest rates for the following positions: (a) Rate-sensitive assets = \$100 million. Rate-sensitive liabilities = \$50 million. Repricing gap = RSA - RSL = \$100 - \$50 million = +\$50 million. NII = (\$50 million)(0.01) = +\$0.5 million (b) Rate-sensitive assets = \$50 million. Rate-sensitive liabilities = \$150 million. Repricing gap = RSA - RSL = \$50 - \$150 million = - \$100 million. NII = (- \$100 million)(0.01) = - \$1 million (c) Rate-sensitive assets = \$75 million. Rate-sensitive liabilities = \$70 million. Repricing gap = RSA - RSL = \$75 - \$70 million = +\$5 million. NII = (\$5 million)(0.01) = \$0.05 million (d) Compare the interest rate risk exposure of the institutions in parts a, b, and c. The FIs in parts a and c are exposed to interest rate declines (positive repricing gap) while the FI in part b is exposed to interest rate increases. The FI in part (c) b has the least (most) amount of interest rate risk exposure since the absolute value of the repricing gap is the lowest (highest).
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Chapter+07+Answers+to+end-of-chapter+questions - CHAPTER 7...

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