Chapter 22 - Managing Interest Rate Risk and Insolvency Risk on the Balance Sheet
Answers to Chapter 22 Questions
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.
Repricing gap = RSA - RSL = $100 - $50 million = +$50 million.
Δ NII = ($50 million)(.01) = +$.5 million, or $500,000.
Repricing gap = RSA - RSL = $50 - $150 million = - $100 million.
Δ NII = (-$100 million)(.01) = -$1 million, or -$1,000,000.
Repricing gap = RSA - RSL = $75 - $70 million = +$5 million.
$Δ NII = ($5 million)(.01) = $.05 million, or $50,000.
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
interest rate risk exposure since the absolute value of the repricing gap is the lowest, while the
opposite is true for part (b).
The repricing model has four general weaknesses:
It ignores market value effects.
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.
It ignores the problem of runoffs, i.e., that assets are prepaid and liabilities are withdrawn
before the maturity date.
It ignores income generated from off-balance-sheet activities.
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:
, i, and
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.
Book value accounting reports assets and liabilities at the original issue values. Market value
s definition of capital. Specifically, the economist
s definition of
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
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