Consider a bank with the following balance sheet (M means million): Assets Value Duration of the Asset Convexity of the Asset Syr bond bought at a yield of 3.4% $550M 4.562 12.026 (lending money) 12yr bond bought at a yield of 4% $800M 53.565 (lending money) 9.453 Liabilities Value Duration of the Liability Convexity of the Liability 2yr bond sold at a yield of 2.4% $300M 1.941 2.384 (borrowing money) 4yr bond sold at a yield of 2.8% $500M 3.759 8.206 (borrowing money) a) If the interest rates go up by 1%, using the durotion and convexity rule to determine the net worth of the bank and the equity to asset ratio. b) In c's scenario, to maintain the equity to asset ratio at 40% which is required by the regulation, the bank decides to raise cash (zero duration and zero convexity) from the equity holders. How much cash does the bank need to raise? c) Do you agree with the following statement? Explain why. "The information about a bond's duration and convexity adjustment is sufficient to quantify interest rate risk exposure."
Consider a bank with the following balance sheet (M means million): Assets Value Duration of the Asset Convexity of the Asset Syr bond bought at a yield of 3.4% $550M 4.562 12.026 (lending money) 12yr bond bought at a yield of 4% $800M 53.565 (lending money) 9.453 Liabilities Value Duration of the Liability Convexity of the Liability 2yr bond sold at a yield of 2.4% $300M 1.941 2.384 (borrowing money) 4yr bond sold at a yield of 2.8% $500M 3.759 8.206 (borrowing money) a) If the interest rates go up by 1%, using the durotion and convexity rule to determine the net worth of the bank and the equity to asset ratio. b) In c's scenario, to maintain the equity to asset ratio at 40% which is required by the regulation, the bank decides to raise cash (zero duration and zero convexity) from the equity holders. How much cash does the bank need to raise? c) Do you agree with the following statement? Explain why. "The information about a bond's duration and convexity adjustment is sufficient to quantify interest rate risk exposure."
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Consider a bank with the following balance sheet (M means million):
Assets
Value
Duration of the Asset
Convexity of the Asset
Syr bond bought at a yield of 3.4% $550M
4.562
12.026
(lending money)
12yr bond bought at a yield of 4%
$800M
53.565
(lending money)
9.453
Liabilities
Value
Duration of the Liability Convexity of the Liability
2yr bond sold at a yield of 2.4%
$300M
1.941
2.384
(borrowing money)
4yr bond sold at a yield of 2.8%
$500M
3.759
8.206
(borrowing money)
a) If the interest rates go up by 1%, using the durotion and convexity rule to determine the net
worth of the bank and the equity to asset ratio.
b) In c's scenario, to maintain the equity to asset ratio at 40% which is required by the regulation,
the bank decides to raise cash (zero duration and zero convexity) from the equity holders.
How much cash does the bank need to raise?
c) Do you agree with the following statement? Explain why.
"The information about a bond's duration and convexity adjustment is sufficient to quantify
interest rate risk exposure."
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