Chap022 - Chapter 22 - Managing Interest Rate Risk and...

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Chapter 22 - Managing Interest Rate Risk and Insolvency Risk on the Balance Sheet Answers to Chapter 22 Questions 1. The length of the repricing period determines which of the securities in a portfolio are rate- sensitive. The longer the repricing period, the more securities either mature or need to be repriced, and, therefore, the more the interest rate exposure. 2. a. Repricing gap = RSA - RSL = $100 - $50 million = +$50 million. Δ NII = ($50 million)(.01) = +$.5 million, or $500,000. b. Repricing gap = RSA - RSL = $50 - $150 million = - $100 million. Δ NII = (-$100 million)(.01) = -$1 million, or -$1,000,000. c. Repricing gap = RSA - RSL = $75 - $70 million = +$5 million. $Δ NII = ($5 million)(.01) = $.05 million, or $50,000. d. 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) has the least amount of interest rate risk exposure since the absolute value of the repricing gap is the lowest, while the opposite is true for part (b). 3. a. The repricing model has four general weaknesses: i. It ignores market value effects. ii. It does not take into account the fact that the dollar value of rate sensitive assets and liabilities within a bucket are not similar. Thus, if assets, on average, are repriced earlier in the bucket than liabilities, and if interest rates fall, FIs are subject to reinvestment risks. iii. It ignores the problem of runoffs, i.e., that assets are prepaid and liabilities are withdrawn before the maturity date. iv. It ignores income generated from off-balance-sheet activities. b. Large banks are able to reprice securities every day using their own internal models so reinvestment and repricing risks can be estimated for each day of the year. 4. The following are rate sensitive: a , b , d , f , g , h , i, and j . 5. When rates rise, the FI manager would want to set the repricing gap greater than zero. As rates rise, interest income will increase by more than interest expense, resulting in an increase in net interest income. If rates are about to fall the manger would like to set the repricing gap less than zero. As rates fall, interest income will decrease by less than interest expense, resulting in an increase in net interest income. 6. Book value accounting reports assets and liabilities at the original issue values. Market value accounting is an economist = s definition of capital. Specifically, the economist = s definition of an FI = s capital, or owners = equity stake, is the difference between the market values of its assets and its liabilities. This is also called an FI = s market value. This is the economic meaning of capital. A problem with book value accounting is that current market values may be different from book values because of changes in market conditions, such as interest rates or
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Chap022 - Chapter 22 - Managing Interest Rate Risk and...

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