Financial Markets and Institutions (2-downloads)

2. Why are secured loans an important method of lend-

ing for financial institutions?

3. “If more customers want to borrow funds at the pre-

vailing interest rate, a financial institution can

increase its profits by raising interest rates on its

loans.” Is this statement true, false, or uncertain?

Explain your answer.

4. Why is being nosy a desirable trait for a banker?

5. A bank almost always insists that the firms it lends

to keep compensating balances at the bank. Why?

6. “Because diversification is a desirable strategy for

avoiding risk, it never makes sense for a financial

institution to specialize in making specific types of

loans.” Is this statement true, false, or uncertain?

Explain your answer.

Q U A N T I TAT I V E   P R O B L E M S

1. A bank issues a $100,000 variable-rate 30-year mort-

gage with a nominal annual rate of 4.5%. If the

required rate drops to 4.0% after the first six months,

what is the impact on the interest income for the first

12 months?

2. A bank issues a $100,000 fixed-rate 30-year mortgage

with a nominal annual rate of 4.5%. If the required rate

drops to 4.0% immediately after the mortgage is issued,

what is the impact on the value of the mortgage?

3. Calculate the duration of a $100,000 fixed-rate 

30-year mortgage with a nominal annual rate of 7.0%.

What is the expected percentage change in value if

the required rate drops to 6.5% immediately after the

mortgage is issued?

4. The value of a $100,000 fixed-rate 30-year mortgage

falls to $89,537 when interest rates move from 5% to

6%. What is the approximate duration of the mortgage?

5. Calculate the duration of a commercial loan. The face

value of the loan is $2,000,000. It requires simple inter-

est yearly, with an APR of 8%. The loan is due in four

years. The current market rate for such loans is 8%.

6. A bank’s balance sheet contains interest-sensitive

assets of $280 million and interest-sensitive liabili-

ties of $465 million. Calculate the income gap.

7. Calculate the income gap for a financial institution with

rate-sensitive assets of $20 million and rate-sensitive

liabilities of $48 million. If interest rates rise from 

4% to 4.8%, what is the expected change in income?

8. Calculate the income gap given the following items:

●

$8 million in reserves

●

$25 million in variable-rate mortgages

●

$4 million in checkable deposits

●

$2 million in savings deposits

●

$6 million of two-year CDs

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Chapter 23 Risk Management in Financial Institutions