BUS307: Calculate the convexity for a three year 4.5 Coupon Rate with a face Value of $500,000 Loan with Amortized Payments: Commercial Banking Coursework, MU, Singapore

QUESTION 1 a

Use this balance sheet information to answer the following questions:

The bank is considering approving a special loan with the following characteristics:

Loan A: The loan that has 4 years to maturity and has bond-like repayments.

Loan B: The loan has repayments of $123.25 at the end of year 1, $575.25 at the end of year 4, $29.25 at the end of year 5 and $34.125 at the end of year 6.

Both loans are trading at par and the yield to maturity is 4.5 percent per annum.

Select the loan that bank should approve. Please provide justification. Assume that both loans have similar default risk.

Assuming a flat yield curve and a parallel shift of the entire yield curve of 50-basis points upward what is the impact on the FI’s market value of equity

QUESTION 1b

Calculate the convexity for a three-year 4.5% coupon rate with a face value of $500,000 loan with amortized payments?

Use this information to determine the impact on the market value of the amortised loan if the entire yield curve shifted downward 50-basis points.

What is the usefulness of convexity when duration is available as a measure of interest rate risk? What is the practical implication for the three-year loan in this example?

QUESTION 2a

Incorporate finance the leverage ratio can be calculated by dividing capital by book value of assets. How have regulators altered this ratio to determine the capital adequacy requirements for banks or authorized depository institutions? Compare Gorajek and Turner’s (2010)[1] analyses to those presented in Lange et al. (2015), Chapter 18. In your discussion consider the tension between the bank and the regulators.

QUESTION 2b

What is a maturity bucket in the repricing model? Why is the length of time selected for repricing assets and liabilities important when using the repricing model? How does this impact runoff?

QUESTION 3a

Data sourced from Ifess (Integrated Fast time Equity System) has given the following swap rates. Think of these swap rates as spot interest rates.

(i)Using the data as given on 30 June 2020, calculate the relevant forward rates. State exactly what information each of these forward rates gives.

(ii)Now using the data from the table for 30 June 2021 state the 1-year, 2-year, 3-and 4-year year spot rates that prevailed on that date. What appears to have happened?

(iii)Using the data as given on 30 June 2021, calculate the relevant forward rates.

QUESTION 3b

A financial institution has the following balance:

In 2020 COVID-19 increased the liquidity needs of a bank servicing the affected community as depositors withdrew deposits to the value of $64 million.

Would you recommend this bank rely more on asset liquidity or liability liquidity to meet these additional requirements? Give reasons. Show how you would manage the bank’s liquidity position. What other information that the financial institution would possess would improve your decision. Be specific.

QUESTION 4a

Some members of the accounting profession are advocating market value accounting for banks.

Explain the arguments for and against market-value accounting. In your answer ensure that you clearly explain “real losses” and “paper losses” and the role of moral hazard in the application of market value accounting. Use a simplified bank balance sheet to illustrate your response.

QUESTION 4b

The risk sharing argument for the existence of loan commitments suggests that borrowers, who are more risk averse than the banks, pay the banks to bear part of the interest rate risk. Explain

QUESTION 4b 

State Bank has the following year-end balance sheet (in millions of dollars

The loans primarily are fixed-rate, medium-term loans, while the deposits are either short-term or variable-rate deposits. Rising interest rates have caused the failure of a key industrial company and, as a result, 3 percent of the loans are considered to be uncollectable and thus have no economic value. One-third of these uncollectable loans will be charged off.

(i) What is the impact on the balance sheet after the necessary adjustments are made according to book value accounting?

(ii) According to market value accounting?

(iii) How will the impact of rising interest rates be incorporated in the analysis?

[1] The article by Gorajek and Turner (2010) is located at the end of the test.