I assets increase by 20 million liabilities by 10

This preview shows page 7 - 9 out of 10 pages.

i. assets increase by 20 million, liabilities by 10 million ii. equity increases by 20 million c. How could the bank protect itself against a change in the exchange rate? i. run a matched book - have the same amount of liabilities and assets in the currency. this way changes in exchange rate have no effect on equity. similar to matching maturities ii. pass risk to customers for credit risk - operate only in one currency. may not be good solution. merely converts exchange rate risk into credit risk (i.e. person borrowers from bank in dollars and dollars rise in value, they have to repay more in terms of their own currency). iii. hedge with currency swaps - convert deposits to dollars and lend in the Eurodollar market or borrow currency in the market then convert it for loans
Image of page 7

Subscribe to view the full document.

8. The market value of a bank’s assets is $20 billion and the market value of its liabilities is $17 billion. The duration of its assets is 2.5 years and the duration of its liabilities is 1.5 years. a. What is the bank’s duration gap? i. 2.5 - 1.5*(17/20) = 1.225 ii. duration gap = measure of sensitivity of value of a bank’s balance sheet to changes in market interest rates. b. Suppose market interest rates fall from 7% to 6%. What is the change in the value of the bank’s equity? i. -1.225 * 20 billion * (-0.01/1.07) = 0.22897 billion ii. 228.972b increase c. If the bank were expecting such a change in interest rates, what should it do? i. a fall in interest rates would allows the bank to profit if it had a positive duration gap - the larger the gap, the higher the profits, so having more assets or assets with longer durations would maximize profits ii. Decrease amount of liabilities held, increase amount of assets. iii. use refinance strategy (borrow long term, lend short term) bc will be cheaper to refinance at lower rates iv. use hedging instrument (buy futures contract, buy call options, enter swap agreement as floating rate payer) 9. For property-liability insurance companies, liquidity is an important concern. Such insurance companies, even large ones, do not generally rely on liquidity management as a source of liquidity. Why not? It is hard to borrow in bad times so hard to ensure credit needs are met. In the event of a natural disaster or other large, unpredictable outflow of cash, it would be hard to find willing lenders because the viability of the company may be in question. PL insurance companies generally invest mainly in marketable short-term assets - asset management. liability management is dependent on being able to borrow at will when needed. property and liability companies won’t need to borrow until there is an incident that requires outflows. if a large catastrophe occurs, no one would be willing to lend to company. if there is doubt about companies credit, the rate at which it can borrow will increase.
Image of page 8
Image of page 9
  • Fall '19

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes