Saunders Interest Rate Risk I Exam Prep Chapter 8

Chapter 08 Interest Rate Risk I

KEY

1. The economic insolvency of many thrift institutions during the 1980s was due, at least in part, to unexpected increases in interest rates. 

2. All FIs tend to mismatch the maturities of their assets and liabilities to some extent. 

3. Because of its complexity, small depository institutions rarely use the repricing, or funding gap, model. 

4. The maturity model of measuring interest rate risk was a first attempt to include the impact on profitability of interest rate changes 

5. Large banks have adopted interest rate risk measurement models based on market value accounting and duration. 

6. Because the increased level of financial market integration has increased the speed with which interest rate changes are transmitted among countries, control of U.S. interest rates by the Federal Reserve is more difficult and less certain. 

7 When the Fed finds it necessary to slow economic activity, it allows interest rates to fall. 

8. Changes in short term interest rates rarely affect the entire term structure of interest rates 

9. The Bank for International Settlements (BIS) requires depository institutions to have interest rate risk management systems. 

10. The repricing gap model is a book value accounting based model. 

11. The repricing model estimates the difference between interest earned and interest paid during a given period of time. 

12. In the repricing gap model, assets or liabilities are rate-sensitive within a given time period if the dollar values of each are subject to receiving a different interest rate should market rates change. 

13. Similar to the repricing gap model, duration gap considers market values and the maturity distributions of an FI’s assets and liabilities. 

14. Duration gap considers the degree of leverage on an FI’s balance sheet as well as the timing of the payment or arrival of cash flows on assets and liabilities.

15. The repricing model is a simplistic approach to focusing on the exposure of net interest income to changes in market levels of interest rates for given maturity periods. 

16. A positive repricing gap implies that a decrease in interest rates will cause interest expense to decrease more than the decrease in interest income. 

17. The cumulative repricing gap position of an FI for a given extended time period is the sum of the repricing gap values for the individual time periods that make up the extended time period. 

18. When a bank's repricing gap is positive, net interest income is positively related to changes in interest rates. 

19. A bank with a negative repricing (or funding) gap faces reinvestment risk. 

20. A bank with a negative repricing (or funding) gap faces refinancing risk. 

21. One reason to include demand deposits when estimating a bank's repricing gap is because rising interest rates could lead to high withdrawals from these accounts. 

22. One reason to exclude NOW accounts when estimating a bank's repricing gap is because the interest rates paid on these accounts typically do not change with the level of market rates. 

23. Few DIs consider demand deposits to be “core” or long-term sources of funds. 

24. Retail passbook savings accounts are included as part of rate-sensitive liabilities because the rates on these accounts rarely change. 

25. Runoff in demand deposits in a repricing model is typically lower during periods of falling interest rates. 

26. The gap ratio is useful because it indicates the scale of the interest rate exposure by dividing the gap by the asset size of the institution. 

27. Because the repricing model ignores the market value effect of changing interest rates, the repricing gap is an incomplete measure of the true interest rate risk exposure of an FI. 

28. Defining buckets of time over a range of maturities assures the capture of all relevant information necessary to accurately assess the interest rate risk exposure of an FI. 

29. Defining buckets of time over wider intervals creates greater accuracy in the use of the repricing model because fewer calculations are required. 

30. If the interest rate spread between rate sensitive-assets and rate sensitive liabilities increases for a bank, future increases in interest rates will lead to an increase in net interest income. 

31. In general, the interest rate spread (spread effect) between rate-sensitive assets and rate sensitive liabilities is positively related to the change in net interest income. 

32. To be more precise in measuring interest rate risk, the runoff component of long-term mortgages should be considered in the time buckets in which the maturities actually occur. 

33. When interest rates increase, banks are more likely to be forced to increase rate-sensitive liabilities to replace decreased balances in demand deposits and savings accounts. 

34. For a given change in interest rates, fixed-rate assets with long-term maturities will have smaller changes in price than assets with shorter maturities. 

35. The market value of a fixed-rate liability will decrease as interest rates rise, just as the market value of a fixed-rate asset will decrease as interest rates rise. 

36. The market value of a fixed-rate liability will increase as interest rates rise, although the market value of a fixed-rate asset will decrease as interest rates rise. 

37. The change in economic value of a fixed-rate liability for a decrease in interest rates is considered to be good news. 

38. An assumption of the repricing model is that interest rate changes will equally affect rate-sensitive assets and rate-sensitive liabilities. 

39. For a given change in interest rates, fixed-rate liabilities with longer-term maturities will have smaller changes in price than liabilities with shorter maturities. 

40. For a given change in interest rates, the change in price for each additional year of maturity of a fixed-rate asset is smaller as the maturity increases. 

41. Reinvestment risk is the risk that the returns on funds to be reinvested will fall below the cost of the funds. 

42. The maturity of a portfolio of assets or liabilities is a weighted average of the maturities of the assets or liabilities that comprise that portfolio. 

43. If the average maturity of assets is 4 years and the average maturity of liabilities is 4 years, then the FI has no interest rate risk exposure. 

44. If the average maturity of assets is 5 years and the average maturity of liabilities is 7 years, then the FI has no interest rate risk exposure. 

45. The maturity gap for a bank is the weighted average maturity of the assets minus the weighted average maturity of the liabilities. 

46. The spread effect demonstrates that, regardless of the direction of a change in market interest rates, a positive relation exists between the changes in spread and changes in net interest income.

47. The repricing model ignores market value effects of interest rate changes. 

48. The repricing model incorporates cash flow effects of off-balance sheet activities of DIs.

49. Overaggregation within maturity buckets using the repricing model causes inaccurate accounting of asset and liability cash flows and, ultimately, net interest income. 

50. Because of its simplicity, smaller depository institutions still use this model as their primary measure of interest rate risk. 

A. The repricing model.

B. The maturity model.

C. The duration model.

D. The convexity model.

E. The option pricing model.

51. The repricing gap approach calculates the gaps in each maturity bucket by subtracting the 

A. current assets from the current liabilities.

B. long term liabilities from the fixed assets.

C. rate-sensitive assets from the total assets.

D. rate-sensitive liabilities from the rate-sensitive assets.

E. current liabilities from tangible assets.

52. Which of the following observations about the repricing model is correct? 

A. Its information value is limited.

B. It accounts for the problem of rate-insensitive asset and liability runoffs and prepayments.

C. It accommodates cash flows from off-balance-sheet activities.

D. It helps to determine an FI's profit exposure to interest rate changes.

E. It considers market value effects of interest rate changes.

53. When repricing all interest-sensitive assets and all interest-sensitive liabilities in a balance sheet, the cumulative gap will be 

A. zero.

B. one.

C. greater than one.

D. a negative value.

E. infinity.

54. The repricing gap does not accurately measure FI interest rate risk exposure because 

A. FIs cannot accurately predict the magnitude change in future interest rates.

B. FIs cannot accurately predict the direction of change in future interest rates.

C. accounting systems are not accurate enough to allow the calculation of precise gap measures.

D. it does not recognize timing differences in cash flows within the same maturity grouping.

E. equity is omitted.

55. The risk that the returns on funds to be reinvested will fall below the cost of the funds is: 

A. reinvestment risk

B. repricing gap

C. rate sensitivity

D. refinancing risk

E. none of the above

56. An FI's net interest income reflects 

A. its asset-liability structure.

B. rates of interest when the assets and liabilities were put on the books.

C. the riskiness of its loans and investments.

D. the cost of its deposit and non-deposit sources of funds.

E. All of the options.

57. A positive gap implies that an increase in interest rates will cause _______ in net interest income. 

A. no change

B. a decrease

C. an increase

D. an unpredictable change

E. no change or a decrease.

58. If interest rates decrease 50 basis points for an FI that has a gap of +$5 million, the expected change in net interest income is 

A. + $2,500.

B. + $25,000.

C. + $250,000.

D. - $250,000.

E. - $25,000.

Feedback: ∆NII = (CGAP) × ∆R
∆NII = +$5,000,000 × (-0.005) = -$25,000

59. If interest rates increase 75 basis points for an FI that has a gap of -$15 million, the expected change in net interest income is 

A. -$112,500.

B. +$112,500.

C. +$1,125,0000.

D. -$1,125,0000.

E. -$150,000.

Feedback: ∆NII = (CGAP) × ∆R
∆NII = (- $15,000,000) × (+0.0075) = -$112,500

60. If interest rates decrease 40 basis points (0.40 percent) for an FI that has a cumulative gap of -$25 million, the expected change in net interest income is 

A. +$100,000.

B. -$100,000.

C. -$625,000.

D. -$250,000.

E. +$250,000.

Feedback: ∆NII = (CGAP) × ∆R
∆NII = (- $25,000,000) × (-0.004) = +$100,000

61. An FI finances a $250,000 2-year fixed-rate loan with a $200,000 1-year fixed-rate CD. Use the repricing model to determine (a) the FI's repricing (or funding) gap using a 1-year maturity bucket, and (b) the impact of a 100 basis point (0.01) decrease in interest rates on the FI's annual net interest income? 

A. $0; $0.

B. -$200,000; +$2,000.

C. -$200,000; -$2,000.

D. +$50,000; -$500.

E. -$200,000; -$1,000.

Feedback: 1-year CGAP = RSA - RSL = $0 - $200,000 = -$200,000
∆NII = (CGAP) × ∆R
∆NII = (- $200,000) × (-0.01) = +$2,000

62. The gap ratio expresses the reprice gap for a given time period as a percentage of 

A. equity.

B. total liabilities.

C. current liabilities.

D. total assets.

E. current assets.

63. What is spread effect? 

A. Periodic cash flow of interest and principal amortization payments on long-term assets that can be reinvested at market rates.

B. The effect that a change in the spread between rates on RSAs and RSLs has on net interest income as interest rates change.

C. The effect of mismatch of asset and liabilities within a maturity bucket.

D. The premium paid to compensate for the future uncertainty in a security's value.

E. The value of an FI to its owners.

64. If an FI's repricing gap is less than zero, then 

A. it is deficient in its required reserves.

B. it is deficient in its capital ratio requirement.

C. its liability costs are more sensitive to changing market interest rates than are its asset yields.

D. its liability costs are less sensitive to changing market interest rates than are its asset yields.

E. the duration of the FI's liabilities exceeds the duration of FI's assets.

65. A bank that finances long-term fixed-rate mortgages with short-term deposits is exposed to 

A. increases in net interest income and decreases in the market value of equity when interest rates fall.

B. decreases in net interest income and decreases in the market value of equity when interest rates fall.

C. decreases in net interest income and increases in the market value of equity when interest rates increase.

D. increases in net interest income and increases in the market value of equity when interest rates increase.

E. decreases in net interest income and decreases in the market value of equity when interest rates increase.

66. The repricing model measures the impact of unanticipated changes in interest rates on 

A. the market value of equity.

B. net interest income.

C. both market value of equity and net interest income.

D. the FI's capital position.

E. the prices of assets and liabilities.

67. Of the following institutions, which will be subject to refinancing risk within a particular reprice bucket?

A. the market value of rate-sensitive liabilities is less than the market value of equity.

B. the book value of rate-sensitive assets is greater than the book value of rate-sensitive liabilities.

C. the market value of rate-sensitive assets is less than the market value of rate-sensitive liabilities.

D. the book value of rate-sensitive liabilities is greater than the book value of rate-sensitive assets.

E. the book value of rate-sensitive assets is less than the book value of equity.

68. Of the following institutions, which will be subject to reinvestment risk within a particular reprice bucket?

A. the market value of rate-sensitive liabilities is less than the market value of equity.

B. the book value of rate sensitive assets is greater than the book value of rate-sensitive liabilities.

C. the market value of rate-sensitive assets is less than the market value of rate-sensitive liabilities.

D. the book value of rate-sensitive liabilities is greater than the book value of rate-sensitive assets.

E. the book value of rate-sensitive assets is less than the book value of equity.

69. Which of the following indicates a positive gap according to the repricing model?

A. the book value of rate-sensitive liabilities is less than the book value of rate-sensitive assets.

B. the book value of rate-sensitive assets is less than the book value of rate-sensitive liabilities.

C. the market value of rate-sensitive assets is less than the market value of rate-sensitive liabilities.

D. the book value of rate-sensitive liabilities is greater than the book value of rate-sensitive assets.

E. the market value of rate sensitive assets is greater than the market value rate sensitive liabilities.

70. If the chosen maturity buckets have a time period that is too long, the repricing model may produce inaccurate results because 

A. as the time to maturity increases, the price volatility increases.

B. price changes will be overestimated.

C. there may be large differentials in the time to repricing for different securities within each maturity bucket.

D. the FI will be unable to accurately measure the quantity of rate-sensitive assets.

E. the FI will be unable to accurately measure the quantity of rate-sensitive liabilities.

71. An increase in interest rates 

A. increases the market value of the FI's financial assets and liabilities.

B. decreases the market value of the FI's financial assets and liabilities.

C. decreases the book value of the FI's financial assets and liabilities.

D. increases the book value of the FI's financial assets and liabilities.

E. has no impact on the market value of the FI's financial assets and liabilities.

72. Which of the following statements is true regarding market value effects? 

A. the repricing model highlights market value effects.

B. interest rate changes have a market value effect in addition to an income effect on asset and liability values.

C. when assuming a book value accounting approach, market value effects are considered.

D. none of the above are true.

E. all of the above are true.

73. Which of the following describes the condition known as runoff in the repricing model approach to measuring interest rate risk of an FI? 

A. Periodic cash flow of interest and principal amortization payments on long-term assets that can be reinvested at market rates.

B. The effect that a change in the spread between rates on RSAs and RSLs has on net interest income as interest rates change.

C. Mismatch of asset and liabilities within a maturity bucket.

D. The relations between changes in interest rates and changes in net interest income.

E. Those deposits that act as an FI's long-term sources of funds.

74. A method of measuring the interest rate or gap exposure of an FI is 

A. the duration model.

B. the maturity model.

C. the repricing model.

D. the funding gap model.

E. All of the options.

75. The repricing model is based on an accounting world that reports asset and liability values at 

A. their market value.

B. their book value.

C. their historic values or costs.

D. their current value or cost.

E. their book value and their historic values or costs.

76. Which of the following is a weakness of the repricing model to measure interest rate risk? 

A. Potential for overaggregation of assets and liabilities within each maturity bucket.

B. It ignores how changes in interest rates affect the market value of assets and liabilities.

C. It ignores the reinvestment of loan interest and principal payments that are reinvested at current market rates.

D. It fails to recognize off-balance-sheet activities that may be rate-sensitive.

E. All of the options.

77. The repricing model ignores information regarding the distribution of assets and liabilities within maturity buckets. This limitation of the model refers to 

A. market value effect.

B. overaggregation.

C. runoffs and pre-payments.

D. OBS activities.

E. the spread effect.

78. Periodic cash flow of interest and principal amortization payments on long-term assets, such as conventional mortgages, that can be reinvested at market rates describes which term? 

A. market value effect.

B. overaggregation.

C. runoffs

D. OBS activities.

E. the spread effect.

79. An interest rate increase 

A. benefits the FI by increasing the market value of the FI's liabilities.

B. harms the FI by increasing the market value of the FI's liabilities.

C. harms the FI by decreasing the market value of the FI's liabilities.

D. benefits the FI by decreasing the market value of the FI's liabilities.

E. benefits the FI by decreasing the market value of the FI's assets.

80. Which of the following statements is true? 

A. An increase in interest rates leads to an increase in the market value of financial securities.

B. Value of longer term securities decreases at a diminishing rate for increases in interest rates.

C. Value of longer term securities increases at an increasing rate for any decline in interest rates.

D. The shorter the maturity of a fixed income asset or liability, the greater the fall in market value for any given interest rate increase.

E. The longer the maturity of a fixed income asset or liability, the greater the fall in market value for any given interest rate decrease.

81. Can an FI immunize itself against interest rate risk exposure even though its maturity gap is not zero? 

A. Yes, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities.

B. No, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities.

C. Yes, because the maturity model does not consider the timing of cash flows.

D. No, because the timing of cash flows is relevant to immunization against interest rate risk exposure.

E. No, because a representative bank will always have a positive maturity gap.

82. Which of the following relationships does NOT hold in the pricing of fixed-rate assets given changes in market rate? 

A. A decrease in interest rates generally leads to an increase in the value of assets.

B. Longer maturity assets have greater changes in price than shorter maturity assets for given changes in interest rates.

C. The absolute change in price per unit of maturity time for given changes in interest rates decreases over time, although the relative changes actually increase.

D. For a given percentage decrease in interest rates, assets will increase in price more than they will decrease in price for the same, but opposite increase in rates.

E. None of the options.

83. The average maturity of the liabilities of an FI's balance sheet is equal to 

A. the weighted-average of the liabilities where the weights are determined relative to the total liabilities and equity of the FI.

B. the weighted-average of the liabilities where the weights are determined relative to the total liabilities of the FI.

C. the weighted-average of the liabilities where the weights are determined relative to the total assets of the FI.

D. the weighted-average of the liabilities where the weights are determined using market values of liabilities.

E. None of the options.

The balance sheet of XYZ Bank appears below. All figures in millions of U.S. dollars.

  

[Reference: 8-84]

84. Total one-year rate-sensitive assets is 

A. $540 million.

B. $580 million.

C. $555 million.

D. $415 million.

E. $720 million.

[Reference: 8-84]

Feedback: One-year rate-sensitive assets
RSA = (short-term consumer loans + 3-month T-bills + 6-month T-notes + 30-year floating rate mortgages)
RSA = (150 + 130 + 135 + 140) = $555

85. Total one-year rate-sensitive liabilities is 

A. $540 million.

B. $580 million.

C. $555 million.

D. $415 million.

E. $720 million.

[Reference: 8-84]

Feedback: One-year rate-sensitive liabilities
RSL = (3-month CDs + 3-month bankers’ acceptances + 6-month commercial paper + 1-year time deposits)
RSL = (140 + 120 + 160 + 120) = $540

86. The cumulative one-year repricing gap (CGAP) for the bank is 

A. $25 million.

B. $-140 million.

C. $15 million.

D. $-150 million.

E. $-15 million.

[Reference: 8-84]

Feedback: Cumulative one-year repricing gap (CGAP)
CGAP = one-year RSA - one-year RSL
CGAP = 555 - 540 = $15 million
CGAP is positive. The bank faces reinvestment risk.

87. The gap ratio is 

A. .015.

B. -.015.

C. .025.

D. -.144.

E. .154.

[Reference: 8-84]

Feedback: Gap ratio = CGAP ÷ Total Assets = $15 million ÷ $970 million = 0.015 or 1.546%

88. Suppose that interest rates rise by 2 percent on both RSAs and RSLs. The expected annual change in net interest income of the bank is 

A. -$300,000.

B. $500,000.

C. -$2,800,000.

D. -$3,000,000.

E. $300,000.

[Reference: 8-84]

Feedback: Effect of 2 percent increase in rates
∆NII = (CGAP) × ∆R
∆NII = $15,000,000 × 0.02 = +$300,000

The following are the assets and liabilities of a government security dealer.

  

[Reference 8-89]

89. Use the repricing model to determine the funding gap for a maturity bucket of 30 days. 

A. -$425 million.

B. -$95 million.

C. -$10 million.

D. -$475 million.

E. +$150 million.

[Refer to: 8-89]

Feedback: 30-day maturity bucket
RSA = 30-day T-Bills; RSL = 14-day repurchase agreement
GAP = RSA - RSL = 150 - 575 = -$425

90. Use the repricing model to determine the funding gap for a maturity bucket of 91 days. 

A. -$60 million.

B. -$150 million.

C. $0.

D. -$250 million.

E. -$300 million.

[Refer to: 8-89]

Feedback: 91-day maturity bucket
RSA = 30-day T-Bills + 91-day T-Bills; RSL = 14-day repurchase agreement
GAP = RSA - RSL = (150 + 275) - 575 = 425 - 575 = $150

91. Use the repricing model to determine the funding gap for a maturity bucket of 365 days. 

A. +$15 million.

B. -$20 million.

C. -$350 million.

D. -$450 million.

E. -$290 million.

[Refer to: 8-89]

Feedback: 365-day maturity bucket
RSA = 30-day T-Bills + 91-day T-Bill + 180-day municipal notes
RSL = 14-day repurchase agreement + 1-year CDs
GAP = RSA - RSL = (150 + 275 + 90) - (575 + 290) = 515 - 865 = $350

92. What is the impact over the next 30 days on the dealer's net interest income if all interest rates increase by 50 basis points? 

A. Net interest income will decrease by $50,000.

B. Net interest income will decrease by $2.125 million.

C. Net interest income will decrease by $475,000.

D. Net interest income will decrease by $2.375 million.

E. Net interest income will increase by $750,000.

[Refer to: 8-89]

Feedback: Change in NII over the next 30 days if rates increase 50 basis points (0.005)
∆NII = (30-day GAP) × ∆R
∆NII = -$425,000,000 × 0.005 = -$2,125,000

The following information details the current rate sensitivity report for Gotbucks Bank, Inc. ($ million).

  [Reference: 8-93]

93. Calculate the funding gap for Gotbucks Bank using (a) a 30 day maturity period and (b) a 91 day maturity period? 

A. -$25 and +$80.

B. -$50 and -$75.

C. -$75 and +$5.

D. +$55 and -$40.

E. 0 and 0.

[Refer to: 8-93]

Feedback: 30-day maturity bucket and 91-day maturity bucket
RSA(30) = Fed Funds + overnight loan bucket + 30-day loan bucket
RSL(30) = Fed Funds + overnight Euro CD bucket + 30 day Euro CD bucket
RSA(30) = (20 + 0 + 10) = $30
RSL(30) = (50 + 5 + 25) = $80
GAP(30) = 30 - 80 = -$50
RSA(91) = Fed Funds + overnight loan bucket + 30-day loan bucket + 91-day loan bucket
RSL(91) = Fed Funds + overnight Euro CD bucket + 30-day Euro CD bucket + 91-day Euro CD bucket
RSA(91) = (20 + 0 + 10 + 15) = $45
RSL(91) = (50 + 5 + 25 + 40) = $120
GAP(91) = 45 - 120 = -$75
Answer is - $50 and - $75

94. How will a decrease of 25 basis points in all interest rates affect Gotbuck's net interest income over a planning period of 91 days? 

A. +$0.1875 million.

B. +$0.1250 million.

C. -$0.1375 million.

D. +$0.0625 million.

E. 0

[Refer to: 8-93]

Feedback: Change in NII over a 91-day planning period if rates decrease rise 25 basis points (-0.0025)
∆NII = (91-day GAP) × ∆R
∆NII = -$75,000,000 × (-0.0025) = +$187,500 or +$0.1875 million.

95. What does Gotbucks Bank's 91-day gap positions reveal about the bank management's interest rate forecasts and the bank's interest rate risk exposure? 

A. The bank is exposed to interest rate decreases and positioned to gain when interest rates decline.

B. The bank is exposed to interest rate increases and positioned to gain when interest rates decline.

C. The bank is exposed to interest rate increases and positioned to gain when interest rates increase.

D. The bank is exposed to interest rate decreases and positioned to gain when interest rates increase.

E. Insufficient information.

[Refer to: 8-93]

Feedback: The bank has a negative 91-day GAP. Therefore, it is positioned to gain if rates decrease and liabilities can be rolled-over at lower cost.

The balance sheet of ARGH Insurance shows the following fixed and rate-sensitive assets and liabilities.

  

[Reference: 8-96]

96. What is the repricing gap for the FI? 

A. $0.

B. $5,000,000.

C. $9,800,000.

D. -$5,000,000.

E. -$8,000,000.

[Refer to: 8-96]

Feedback: GAP = RSA - RSL = ($35,000,000 - $40,000,000) = -$5,000,000

97. What will be the FI's net interest income at year-end if interest rates do not change? 

A. $3.20 million.

B. $5.39 million.

C. $4.04 million.

D. $1.89 million.

E. $1.35 million.

[Refer to: 8-96]

Feedback: NII if rates remain unchanged
NII = (RSAj × Rj) - (RSLi × Ri)
II = ($35,000,000 × 0.10) + ($21,000,000 × 0.09) = $3,500,000 + $1,890,000 = $5,390,000
IE = ($40,000,000 × 0.08) + ($12,000,000 × 0.07) = $3,200,000 + $840,000 = $4,040,000
NII = $5,390,000 - $4,040,000 = $1,350,000

98. Suppose short-term interest rates increase by 1 percent. Calculate the change in net interest income after the interest rate increase. 

A. $50,000.

B. $18,900.

C. $40,400.

D. $53,900.

E. $32,000.

[Refer to: 8-96]

Feedback: Interest rate changes only affect rate-sensitive assets and liabilities. Therefore, GAP may be used to find the effect of an increase of 1 percent or 100 basis points.
∆NII = (GAP) × ∆R
∆NII = -$5,000,000 × 0.01 = + $50,000

The following information is from First Yaupon Savings Association.

 

[Reference: 8-99]

99. What is the repricing gap over the 1-year maturity bucket? 

A. +$100 million.

B. -$500 million.

C. -$100 million.

D. +$500 million.

E. -$900 million.

[Refer to: 8-99]

Feedback: 1-year reprice gap
GAP = RSA - RSL = (1-year T-bills - 1-year CDs) = ($400 - $900) = −$500 million

100. If all interest rates decrease by 15 basis points, what is the expected impact on the FI's net interest income? (Hint: Use the repricing model to answer this question.) 

A. +$150,000.

B. -$150,000.

C. -$750,000.

D. +$750,000.

E. No change.

[Refer to: 8-99]

Feedback: Effect of a decrease in rates of 15 basis points (-0.0015)
∆NII = (GAP) × ∆R
∆NII = -$500,000,000 × (-0.0015) = +$750,000

The following is the balance sheet of Boston Bank. The average maturity of demand deposits is estimated at 2 years.

 [Reference 8-101] 

101. What is the repricing gap if a 0 to 3 month maturity gap is used? Ignore runoffs. 

A. $60 million.

B. $40 million.

C. -$80 million.

D. -$120 million.

E. -$180 million.

[Refer to: 8-101]

Feedback: 3-month reprice GAP
GAP = RSA - RSL; note that there are no liabilities that will reprice over the next 30 days.
GAP = $60 million. (The amount of 3-month T-bills asset)

102. What is the repricing gap if a 3-year maturity gap is used? Ignore runoffs. 

A. $21 million.

B. $44 million.

C. -$80 million.

D. -$60 million.

E. -$120 million.

[Refer to: 8-101

Feedback: 3-year maturity GAP
GAP(3yr) = RSA(3yr) - RSL(3yr)
GAP(3yr) = (3-month T-Bills + 2-year Bonds) - (Demand Deposits)
GAP (3yr) = (60 + 60) - 180 = 120 - 180 = −$60 million

103. What is the repricing gap if a 1-year maturity gap is used if runoffs are also considered? 

A. -22 million.

B. +$22 million.

C. +$53 million.

D. -$40 million.

E. -$70 million.

[Refer to: 8-101]

Feedback: If runoffs are considered, one must estimate the value of each balance sheet account at the end of the year given the percentage the each account will decrease because of runoffs.

TA(end-of-year) = [2-year bonds × (1 - 2-year runoff rate)] + [5-year bonds × (1 - 5-year runoff rate)] + unknown balance of T-bills
TAyear-end) = [$60 × (1 - 0.05)] + [$80 × 1 - 0.10)] + T-Bills = $57 + $72 + T-Bills = $129 + T-Bills.

TL(year-end) = [Demand Deposits × (1 - run-off rate for demand deposits)]
TL(year-end) = [$180 × (1 - 0.10)] = $162

Accounting Equation: TA = TL + E
$129 + T-Bills = $162 + $20
T-Bills = $182 - $129 = $53 million

Since T-bills are the only asset that will reprice within one year, the on-year GAP is +$53 million.

104. What is the impact on net interest income in year two if interest rates increase by 50 basis points at the end of year one? Ignore runoffs. 

A. +$0.210 million.

B. +$0.300 million.

C. -$0.300 million.

D. -$0.210 million.

E. +$0.600 million.

[Refer to: 8-101

Feedback: Find 2- year GAP first. Reminder to ignore runoffs

GAP(2-year) = RSA(2) - RSL(2)
GAP(2-year) = (3-month T-bills + 2-year bonds) - (Demand deposits)
GAP(2-year) = ($60 + $60) - $180 = -$60 million. same as the 3-year gap found previously

Change in NII next year if interest rates increase 50 basis points (+0.005)

∆NII = (2-year GAP) × ∆R
∆NII = -$60,000,000 × 0.005 = -$300,000 or -$0.300 million

Hadbucks National Bank current balance sheet appears below. All assets and liabilities are currently priced at par and pay interest annually.

  

[Reference: 8-105]

105. What is the weighted average maturity of assets? 

A. 5.50 years.

B. 6.40 years.

C. 5.00 years.

D. 4.60 years.

E. 10.0 years.

[Refer to: 8-105]

Feedback: Weighted-average maturity of assets



The weighted average maturity of assets is 4.60 years

106. What is the weighted average maturity of liabilities? 

A. 5.50 years.

B. 6.40 years.

C. 1.44 years.

D. 1.30 years.

E. 1.10 years.

[Refer to: 8-105]

Feedback: Weighted average maturity of liabilities



The weighted average maturity of liabilities is 1.44 years

106. What is this FI's maturity gap? 

A. 4.00 years.

B. 4.28 years.

C. 3.16 years.

D. 4.06 years.

E. 5.10 years.

[Refer to: 8-105]

Feedback: MGAP = M_A - M_L = 4.60 - 1.44 = 3.16 years

107. What is market value of the one-year bond if all market interest rates increase by 2 percent? 

A. $60.000 million.

B. $60.566 million.

C. $59.444 million.

D. $58.899 million.

E. $61.142 million.

[Refer to: 8-105]

Feedback: Market value of 1-year bond if rates increase 2 percent.

108. What is market value of the ten-year loan if all market interest rates increase by 2 percent? 

A. $40.000 million.

B. $44.916 million.

C. $37.830 million.

D. $42.356 million.

E. $35.827 million.

[Refer to: 8-105]

Feedback: Market value of 10-year loan if rates increase 2 percent.

109. What is market value of the one-year CD if all market interest rates increase by 2 percent? 

A. $49.065 million.

B. $50.481 million.

C. $49.528 million.

D. $50.971 million.

E. $50.000 million.

[Refer to: 8-105]

Feedback: Market value of 1-year CD if rates increase 2 percent.

104. What is market value of the two-year CD if all market interest rates increase by 2 percent? 

A. $40.381 million.

B. $39.626 million.

C. $40.000 million.

D. $38.573 million.

E. $40.769 million.

[Refer to: 8-105]

Feedback: Market value of 2-year CD if rates increase 2 percent.

110. What is the impact on the FI's equity of a 2 percent overall increase in market interest rates on all fixed-rate instruments? 

A. Equity rises by $4.318 million.

B. Equity declines by $2.912 million.

C. Equity rises by $2.060 million.

D. Equity declines by $1.880 million.

E. Equity does not change.

[Refer to: 8-105]

Feedback: Change in equity due to a 2 percent increase in market rates:
∆E = ∆A - ∆L
∆A = (58,899,082-60,000,000)+(35,827,107-40,000,000)= -1,100,918 - 4,172,893 = -$5,273,811
∆L = (49,065,420-50,000,000)+(38,573,388-40,000,000) = -934,580 - 1,426,612 = -$2,361,192
∆E = -$5,273,811 - (-2,361,192) = -$2,912,619
The value of equity will fall $2.912 million.

111. Which of the following statements is true? 

A. An increase in interest rates will benefit the FI since the increase in the market value of assets will be greater than the increase in the market value of liabilities.

B. An increase in interest rates will harm the FI since the increase in the market value of assets will be greater than the increase in the market value of liabilities.

C. An increase in interest rates will harm the FI since the decrease in the market value of assets will be greater than the decrease in the market value of liabilities.

D. A decrease in interest rates will harm the FI since the increase in the market value of assets will be greater than the increase in the market value of liabilities.

E. A decrease in interest rates will benefit the FI since the increase in the market value of assets will be smaller than the increase in the market value of liabilities.

112. Can the FI immunize itself from interest rate risk exposure by setting the maturity gap equal to zero? 

A. Yes, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities.

B. No, because with a maturity gap of zero, the change in the market value of assets exactly offsets the change in the market value of liabilities.

C. No, because the maturity model does not consider the timing of cash flows.

D. Yes, because the timing of cash flows is not relevant to immunization against interest rate risk exposure.

E. No, because a representative bank will always have a positive maturity gap.

Duration Bank has the following assets and liabilities as of year-end. All assets and liabilities are currently priced at par and pay interest annually.

 [Reference: 8-113] 

113. What is the weighted average maturity of the assets of the FI? 

A. 2.0 years.

B. 2.3 years.

C. 2.5 years.

D. 2.6 years.

E. 3.0 years.

[Refer to: 8-113]

Feedback: Weighted-average maturity of assets



The weighted average maturity of assets is 2.60 years

114. What is the weighted average maturity of the liabilities of the FI? 

A. 3.67 years.

B. 3.30 years.

C. 3.00 years.

D. 5.00 years.

E. 4.33 years.

[Refer to: 8-113]

Feedback: Weighted average maturity of liabilities



The weighted average maturity of liabilities is 3.67 years

115. What is the FI's maturity gap? 

A. -2.03 years.

B. -2.50 years.

C. -1.07 years.

D. -0.70 years.

E. -0.40 years.

[Refer to: 8-113]

Feedback: MGAP = M_A - M_L = 2.6 - 3.67 = -1.07 years

116. Is the bank exposed to interest rate increases or decreases and why? 

A. Interest rate increases because the value of its assets will rise more than its liabilities.

B. Interest rate increases because the value of its assets will fall more than its liabilities.

C. Interest rate decreases because the value of its assets will rise less than its liabilities.

D. Interest rate decreases because the value of its assets will fall more than its liabilities.

E. Interest rate increases because the value of its assets will fall less than its liabilities.

[Refer to: 8-113]

Feedback: A negative MGAP, and considering only the value of assets and liabilities, and the selections offered, and effect on net worth:

a. Interest rate increases because the value of its assets will rise more than its liabilities.
(interest rate increases will cause value to fall, not rise)
b. Interest rate increases because the value of its assets will fall more than its liabilities.
(here, the value of liabilities, not assets, will fall more)
c. Interest rate decreases because the value of its assets will rise less than its liabilities.
(this is true)
d. Interest rate decreases because the value of its assets will fall more than its liabilities.
(interest rate decreases cause values to rise, not fall)
e. Interest rate increases because the value of its assets will fall less than its liabilities.
(this is true as well, but it is a desirable outcome, so the bank is not "exposed" to this scenario)

117. What is the change in the value of its assets if all interest rates decrease by 1 percent? 

A. Approximately $1.613 million.

B. Approximately $2.297 million.

C. Approximately -$1.937 million.

D. Approximately $2.209 million.

E. Approximately $2.524 million.

[Refer to: 8-113]

Feedback: Market value of 2-year loans if rates decrease by 1 percent.



Market value of 3-year loans if rates decrease 1 percent.



∆A = (40,723,207 - 40,000,000) + (61,574,590 - 60,000,000) = 723,207 + 1,574,590 = $2,297,797

118. What is the change in the value of its liabilities if all interest rates decrease by 1 percent? 

A. Approximately $2.003 million.

B. Approximately -$2.355 million.

C. Approximately $2.697 million.

D. Approximately $2.906 million.

E. Approximately $3.211 million.

[Refer to: 8-113]

Feedback: Market value of 3-year CD if rates decrease by 1 percent.



Market value of 5-year term loan if rates decrease 1 percent.



∆L = (61,603,807 - 60,000,000) + (31,298,843 - 30,000,000) = 1,603,807 + 1,298,843 = $2,902,650

119. What is the effect on the value of the FI's equity if interest rates decrease by 1 percent? 

A. Gain of $0.697 million.

B. Gain of $0.338 million.

C. Loss of $1.622 million.

D. No change in equity.

E. Loss of $0.605 million.

[Refer to: 8-113]

Feedback: ∆E = ∆A - ∆L
∆E = $2,297,797 - 2,902,650 = -$604,853 or $0.605 million
The value of equity will fall $604,853.

The following question are based on material in Appendix 8B

118. The term structure of interest rates assumes that 

A. the risk of all assets is the same.

B. the time to maturity for all assets is the same.

C. the coupon rate of all assets is the same.

D. The market value of assets is the same.

E. All of the options.

119. The yield curve 

A. relates rates for different maturities of assets.

B. for U.S. Treasury securities is the most commonly reported yield curve.

C. may change shape over time.

D. which is inverted does not last very long.

E. All of the options.

120. The unbiased expectations theory of the term structure of interest rates 

A. assumes that long-term interest rates are an arithmetic average of short-term rates.

B. assumes that the yield curve reflects the market's current expectations of future short-term interest rates.

C. recognizes that forward rates are perfect predictors of future interest rates.

D. assumes that risk premiums increase uniformly with maturity.

E. None of the options.

121. The liquidity premium theory of the term structure of interest rates 

A. assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term.

B. assumes that long-term interest rates are an arithmetic average of short-term rates plus a liquidity premium.

C. recognizes that forward rates are perfect predictors of future interest rates.

D. assumes that risk premiums increase uniformly with maturity.

E. None of the options.

122. The market segmentation theory of the term structure of interest rates 

A. assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term.

B. assumes that the yield curve reflects the market's current expectations of future short-term interest rates.

C. assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity buckets.

D. fails to recognize that forward rates are not perfect predictors of future interest rates.

E. assumes that both investors and borrowers are willing to shift from one maturity sector to another to take advantage of opportunities arising from changing yields.

123. Which theory of term structure posits that long-term rates are a geometric average of current and expected short-term interest rates? 

A. The unbiased expectations theory.

B. The liquidity premium theory.

C. The loanable funds theory.

D. The market segmentation theory.

E. None of the options.

124. Which theory of term structure states that long-term rates are equal to the geometric average of current and expected short-term rates plus a risk premium that increases with the maturity of the security? 

A. The unbiased expectations theory.

B. The liquidity premium theory.

C. The loanable funds theory.

D. The market segmentation theory.

E. None of the options.

125. Which theory of term structure argues that individual investors have specific maturity preferences? 

A. The unbiased expectations theory.

B. The liquidity premium theory.

C. The loanable funds theory.

D. The market segmentation theory.

E. None of the options.