Question 1: (question + solution)

This is a typical year for bank V

Its balance sheet has been as following during the year

Amount Interest Amount

Interest
rate
rate

5 year fixed rate corporate loans 1000 4% equity 250

20 year fixed rate mortgage loans 200 4.5 % sight deposit 1300
1%
(Current accounts)
3 month Trade Bills 800 3% 3 months clients deposits
900 1,5 %
3 month Banks loans 600 2% 3 months Bank deposit 550
2%
5 year fixed rate Treasury Bonds 400 3.5 %

This Bank earns this year 15 in fees and commissions

It pays this year 65 in overhead costs; of this 20 is the overhead cost of the
corporate business, spread 25 % for corporate lending and 75 % for Trade Bills.

It has to provision and amortise 10 for bad loans, of which 1 for losses on
mortgage loans, 7 for losses on corporate loans, and 2 for losses on Trade Bills.

-What is the total interest margin of the bank?

o In absolute amount?
Interest margin = interest received – Interest paid
Interest received = 1000 * 4% + 200 * 4.5% + 800*3% + 600*2% + 400*3.5% =
99
Interest paid = 1300 * 1% + 900*1.5% + 550* 2% = 37.5
Interest margin (absolute) = interest received – interest paid = 99-37.5 = 61.5

o In percentage?
Interest margin (%) = ( interest received – Interest paid)/total asset
= 61.5*100/3000 =2.05%

-What is the return on equity of the Bank?

Profit = total revenue – total cost
 = ( total interest received + fees and commission ) – (total interest paid +
overhead + provision)
= (99 + 15) – (37.5+ 65 + 10) = 6
ROE = 6*100/250 = 2,5%

-What is the risk asset ratio (Basel I) of the Bank?

Risk assets = 1000 * 100% + 200*50% + 800 * 100% + 600*20% + 400 * 0% =
2020
RAR = 250*100/2020 = 12.376% > required rate of 8% => the bank is safety,
but the profitability may be less than possible.
-Does the Bank have an interest rate exposure, if yes, which one? (2 lines)
The bank has interest rate exposure, because
Total assets with fix rate = 1600; Total liabilities with fix rate = 0 => interest rate
sensitivity gap >0 => the bank will face with interest risk if the interest rates in the
market go down.

-How could the bank improve its risk asset ratio (make 2 proposals) and how
would any proposal influence 1) its return on equity and 2) its interest rate
position?(6lines)
As the RAR is over 8%, it is not neccesary to improve this ratio.

If this ratio is less than 8%, in order to improve RAR, the bank has two choices:
+ First, Increase the equity and at the same time increase the T-bond and bank
loans
+ Keeping the equity the same, reduce the assets with 100% of risk ratio (e.g
corporate loan, increase T-bond and bank loans to ensure total assets the same)

Question 2: For your homework

Matching assets and liabilities

The information of bank A is as followed (on average)

Trade bills 150 4% equity 20

Overdraft 100 7% sight deposit 230 1,5
%
Corporate loans 300 3,5 % term deposits 300 2,5
% floating rate (3 months)
Mortgage loans 300 7% banks (3 months) 250 3 %
Banks (3 months) 50 3% bonds (5 years fixed) 200 4,5
%
Government 100 5%
bonds (5 years fixed rate)

Commissions 17
Overhead and general expenses 30 (of which, loan losses: 5)
Net provisions 4
a. What is the total interest margin of the bank?
o In absolute amount?
o In percentage?
b. What is the return on equity of the Bank?
c. What is the risk asset ratio (Basel I) of the Bank?
d. Does the Bank have an interest rate exposure, if yes, which one?
e. How could the bank improve its risk asset ratio (make 2 proposals) and
how would any proposal influence 1) its return on equity and 2) its interest
rate position?

Question 3: Interest rate risk calculation and analysis.

Pls read the Appendix 1 to Chapter 9 – Mishkin’s electronic Book – pages 296-
304