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? e) 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.”
please question D and E is required.
Bond
Consider a bank with the following
Assets Value Duration of the Asset Convexity of the Asset
5yr bond bought at a yield of 3.4% (lending money) $550M 4.562
12.026
12yr bond bought at a yield of 4% (lending money) $800M 9.453
53.565
Liabilities Value Duration of the Liability Convexity of the Liability
2yr bond sold at a yield of 2.4% (borrowing money) $300M 1.941 2.384
4yr bond sold at a yield of 2.8% (borrowing money) $500M 3.759 8.206
a) Calculate the equity (total asset – total liability) to asset ratio of the bank
(Hint: equity to asset ratio = total equity/total asset)
b) Calculate the duration and convexity of the both asset and liability sides;
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, the bank decides to raise cash (zero duration and zero convexity) from the equity holders. How much cash does the bank need to raise?
e) 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.”
Trending now
This is a popular solution!
Step by step
Solved in 2 steps with 2 images
