Dr.

Le Anh Tuan

Solutions for Session 4 – Interest rate risk

S4.1

a.
RSA=$62.50+$37.50+$43.75+$50.00=$193.75 million
RSL=$50+$25+$75+$25=$175 million
CGAP = (One-year RSA) - (One-year RSL) = RSA - RSL = $193.75 million - $175 million =
$18.75 million
b.
If ∆R=1%, then ∆NII = CGAP x ∆R= ($18.75 million) x 0.01 = $187,500
If ∆R=-1%, then ∆NII = ($18.75 million) x (-0.01) = -$187,5000
c.
The resulting change in NII is calculated as:
∆NII = [RSA x ∆R ] - [RSL x ∆R ]
RSA RSL

= [$193.75 million x 1.2%] - [$175 million x 1.0%]

= $2.325 million - $1.75 million
= $575,000

S4.2

a.
Current expected interest income: $50m(0.10) + $50m(0.07) = $8.5m.
Expected interest expense: $70m(0.06) + $20m(0.07) = $5.6m.
Expected net interest income: $8.5m - $5.6m = $2.9m.

b.

After the 2 percent interest rate increase, net interest income declines to:
50(0.12) + 50(0.07) - 70(0.08) - 20(.07) = $9.5m - $7.0m = $2.5m, a decline of $0.4m.
c.
GAP= $50m - $70m = -$20m.
DNII= (-$20m)(0.02) = -$0.4m.
d.

After the unequal rate increases, change in net interest income will be
50*0.02-70*0.01=$0.3m
It is not uncommon for interest rates to adjust in an unequal manner on RSAs versus RSLs.
Interest rates often do not adjust solely because of market pressures. In many cases, the changes
are affected by decisions of management. Thus, you can see the difference between this answer
and the answer for part a.

S4.3
 Dr. Le Anh Tuan

a.
CF = ($100,000 x 0.12 x ½) + $50,000 = $56,000 interest and principal.
1/2

CF = ($50,000 x 0.12 x ½) + $50,000 = $53,000 interest and principal.

1

b.
PV of CF = $56,000/1.06 = $52,830.19
1/2

PV of CF = $53,000/(1.06) = 47,169.81
1
2

PV Total CF = $100,000.00

c.
X = $52,830.19 ÷ $100,000 = 0.5283 = 52.83%
1/2

X = $47,169.81 ÷ $100,000 = 0.4717 = 47.17%

1

d.
Duration = 0.5283(1/2) + 0.4717(1) = 0.7358

OR
t CF PVof CF PV of CF x t
½ $56,000 $52,830.19 $26,415.09
1 53,000 47,169.81 47,169.81
$100,000.00 $73,584.91

Duration = $73,584.91/$100,000.00 = 0.7358 years

S4.4

Two-year Bond: Par value = $1,000 Coupon rate = 10% Annual payments
R = 14% Maturity = 2 years
t CF DF
t t CF x DFt CF x DF x t
t t t

1 100 0.8772 87.72 87.72

2 1,100 0.7695 846.41 1,692.83
934.13 1,780.55
Duration = $1,780.55/$934.13 = 1.9061

The expected change in price = - dollar duration x ∆R = - MD x ∆R =

- (1.9061/1.14) x (-0.0050) x $934.13 = $7.81. This implies a new price of $941.94 ($934.13 +
$7.81). The actual price using conventional bond price discounting would be $941.99. The
difference of $0.05 is due to convexity, which is not considered in the duration elasticity measure.

S4.5

a.

Five-year Loan (values in millions of $s)

Par value = $65 Coupon rate = 12% Annual payments
R = 12% Maturity = 5 years
t CFt DFt CFt x DFt CFt x DFt x t
1 7.8 0.8929 6.964 6.964
 Dr. Le Anh Tuan

2 7.8 0.7972 6.218 12.436

3 7.8 0.7118 5.552 16.656
4 7.8 0.6355 4.957 19.828
5 72.8 05674 41.309 206.543
65.000 262.427
Duration = $262.427/$65.000 = 4.0373

b.

DA = [$30(0) + $20(0.36) + $105(0.36) + $65(4.0373)]/$220 = 1.3974 years

 Dr. Le Anh Tuan

c.

Two-year Core Deposits (values in millions of $s)

Par value = $20 Coupon rate = 8% Annual payments
R = 8% Maturity = 2 years
t CFt DFt CFt x DFt CFt x DFt x t
1 1.6 0.9259 1.481 1.481
2 21.6 0.8573 18.519 37.037

20.000 38.519
Duration = $38.519/$20.000 = 1.9259

d.

DL = [$20(1.9259) + $50(0.401) + $130(0.401)]/$200 = 0.5535 years

e.

GBI’s leveraged adjusted duration gap is: 1.3974 - 200/220 x (0.5535) = 0.8942 years

Since GBI’s duration gap is positive, an increase in interest rates will lead to a decrease in the
market value of equity.

f.

For a 1 percent increase, the change in equity value is:

ΔE = -0.8942 x $220,000,000 x (0.01) = -$1,967,280 (new net worth will be $18,032,720).

g.

For a 0.5 percent decrease, the change in equity value is:

ΔE = -0.8942 x (-0.005) x $220,000,000 = $983,647 (new net worth will be $20,983,647).

h.
 Dr. Le Anh Tuan

Immunization requires the bank to have a leverage adjusted duration gap of 0. Therefore, GBI

could reduce the duration of its assets to 0.5032 (0.5535 x 200/220) years by using more fed funds

and floating rate loans. Or GBI could use a combination of reducing asset duration and increasing

liability duration in such a manner that DGAP is 0.

S4.6

a.

Assets Repricing period

Cash $31 Not rate sensitive
Fed funds (2.05%) 150 6-months
3-month T-bills (3.25%) 200 6-months
8-year T-bonds (6.50%) 250 Not rate sensitive
5-year munis (7.20%) 50 Not rate sensitive
6-month consumer loans (5%) 250 6-months
5-year car loans (6%) 350 Not rate sensitive
7-month C&I loans (4.8%) 200 1-year
2-year C&I loans (4.15%) 275 Not rate sensitive
Fixed-rate mortgages (5.10%)
(maturing in 5 months) 450 6-months
Fixed-rate mortgages (6.85%)
(maturing in 1 year) 300 1-year
Fixed-rate mortgages (5.30%)
(maturing in 5 years) 275 Not rate sensitive
Fixed-rate mortgages (5.40%)
(maturing in 20 years) 355 Not rate sensitive
Premises and equipment 20 Not rate sensitive
 Dr. Le Anh Tuan

Liabilities and Equity Repricing Period

Demand deposits $253 Not rate sensitive
Savings accounts (0.5%) 50 6-months
MMDAs (3.5%)
(no minimum balance requirement) 460 6-months
3-month CDs (3.2%) 175 6-months
1-year CDs (3.5%) 375 1-year
5-year CDs (5%) 350 Not rate sensitive
Fed funds (2%) 225 6-months
Repos (2%) 290 6-months
6-month commercial paper (4.05%) 300 6-months
Subordinate notes
1-year fixed rate (5.55%) 200 1-year
Subordinated debt
7-year fixed rate (6.25%) 100 Not rate sensitive
Equity 400 Not rate sensitive

6-month repricing gap: RSAs = $150m. + $200m. + $250m. + $450m. = $1050m.

RSLs = $50m. + $460m. + $175m. + $225m. + $290m. + $300m. = $1500m.
CGAP = $1050m. - $1500m. = -$450m.
1-year repricing gap: RSAs = $1050m. + $200m. + $300m. = $1550m.
RSLs = $1500m. + $375m. + $200m. = $2075m.
CGAP = $1550m. - $2075m. = -$525m.

b.

DA = [31(0) + 150(0.02) + 200(0.22) + 250(7.55) + 50(4.25) + 250(0.42) + 350(3.78) + 200(0.55)

+ 275(1.65) + 450(0.48) + 300(0.85) + 275(4.45) + 355(18.25) + 20(0)]/3,156 = 3.90122
years

DL = [253(0) + 50(1.25) + 460(0.50) + 175(0.20) + 375(0.95) + 350(4.85) + 225(0.02) +

290(0.05) + 300(0.55) + 200(0.92) + 100(6.65))]/2,778 = 1.22903 years

DGAP = DA - kDL = 3.90122 - ($2,778/$3,156)(1.22903) = 2.81939 years

c.

ΔNII (6-months) = ΔII (6-months) – ΔIE (6-months)

= $1050m.(0.0050) - $1500m.(0.0035) = $0m.
 Dr. Le Anh Tuan

GAP is negative and interest rates are expected to go up. Therefore, the GAP effect pushes NII
down. However, at the same time the spread increases. So, the spread affect pushes NII up. Thus,
despite the fact that the GAP works against the bank, reducing its NII, the spread affect exactly
offsets this, increasing NII by the same amount. The net effect is no change in NII.

d.

ΔNII (1-year) = ΔII (1-year) – ΔIE (1-year)

= $1505m.(-0.0035) - $2075m.(-0.0050) = $4.95m.
GAP is negative and interest rates are expected to go down. Therefore, the GAP effect pushes NII
up. At the same time the spread decreases. So, the spread affect pushes NII up. Thus, both the
GAP effect and the spread affect work to increase NII.

ΔNII (1-year) = ΔII (1-year) – ΔIE (1-year)

= $1550m.(0.0035) - $2075m.(0.0050) = $4.95m.
GAP is negative and interest rates are expected to go up. Therefore, the GAP effect pushes NII
down. At the same time the spread decreases. So, the spread affect pushes NII down. Thus, both
the GAP effect and the spread affect work to decrease NII.

e.
ΔMVE = ΔMVA – ΔMVL = $40,851,889 – ($16,283,040) = $24,568,849

f.
ΔMVE = DGAP x A x ΔR/(1 + R) = -2.81939 years x 3,156m x (-0.0050) = $44.49m

S4.7

∆𝑁𝐼𝐼 = (𝑅𝑆𝐴 − 𝑅𝑆𝐿) ∗ ∆𝑅

For Valley Bank, NII increases when rates rise, but decreases when rates fall => RSA>RSL, asset
sensitive, reinvestment risk.

For City Bank, NII increases when rates decrease, but decreases when rates increase => RSA<RSL,
liability sensitive, refinancing risk.

S4.8

a.
GAP = RSA-RSL=100-80=20
Expected NII=100*5%+150*8%-80*3%-160*4.5%=7.4
Expected NIM=7.4/(100+150)=2.96%
RSA>RSL => NII will increase if interest rates increase
b.
∆NII=GAP*∆R=20*2%=$0.4 million
Expected NIM=7.8/(100+150)=3.12%
 Dr. Le Anh Tuan

c.
∆NII=100*0.5%-80*1%=-0.3
Expected NIM=7.1/(100+150)=2.84%
d.
GAP adjusting for run-offs =20+10-15=15
Change in net income = 15*1% = 0.15