Consider a bank with the following balance sheet (M means million): Assets Value Duration of the Asset Convexity of the Asset $550M 5yr bond bought at a yield of 3.4% (lending money) 4.562 12.026 12yr bond bought at a yield of 4% $800M 9.453 53.565 (lending money) Liabilities Value Duration of the Liability Convexity of the Liability $300M 2yr bond sold at a yield of 2.4% (borrowing money) 1.941 2.384 4yr bond sold at a yield of 2.8% $500M 3.759 8.206 (borrowing money)
Macrohedging
Hedging or hedge accounting is a risk-mitigation technique used to protect the current financial position from potential losses. Hedging is often confused with speculating. The major difference between the two is that hedging does not involve guessing, whereas speculation is based on guessing the direction of movement of the underlying asset to book profits.
Finance Mathematics
The area of applied mathematics known as mathematical finance, also known as quantitative finance or financial mathematics is concerned with the mathematical modeling of financial markets. The application of mathematical methods to financial problems is known as financial mathematics. A financial market is a place where people can exchange low-cost financial securities and derivatives. Stocks and bonds, raw materials, and precious metals, both of which are regarded as commodities in the stock markets, are examples of securities. It uses probability, statistics, stochastic processes, and economic theory as methods.
c) If the interest rates go up by 1%, using the duration and convexity rule to determine the net
worth of the bank and the equity to asset ratio
d) In c)’s scenario, to maintain the equity to asset ratio at 40% which is required by the regulation,
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the bank decides to raise cash (zero duration and zero convexity) from the equity holders.
How much cash does the bank need to raise?
D) IS IN NEED ONLY. plz show the process.
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