FIN 306 Final Exam QUESTIONS &
ANSWERS(RATED A+)
True or False?
A rate sensitive asset is an asset whose interest rates will be repriced or changed over
some future period. - ANSWERTrue
True or False
If a bank has a negative repricing gap, the bank is exposed to refinancing risk, or the
risk that interest rates will increase and the cost of rolling over or reborrowing funds will
be higher than the interest revenue being earned on assets. - ANSWERTrue
A bank has rate sensitive assets of $100 and rate sensitive liabilities of $70. If interest
rates increased by 1%, what would be the expected annual change in net interest
income? - ANSWER$0.30
100-70 = 30
1% x 30 = .30
A bank is facing a forecast of rising interest rates. What is the ideal repricing and
duration gap? - ANSWERPositive repricing gap and negative duration gap
A negative repricing gap is preferred when interest rates are expected to rise (interest
income will go up by more than interest expense goes up), and the negative duration
gap implies a positive relationship between changes in interst rates and changes in the
market value of the financial institution.
True or False
The higher the duration, the less sensitive the bond price is to changes in interest rates.
- ANSWERFalse
A bank has three assets. It has $75 million invested in consumer loans with a 3-year
duration, $39 million invested in T-Bonds with a 16-year duration, and $39 million in 6-
month maturity T-Bills with a 0.5-year duration. What is the duration of the bank's asset
portfolio in years? - ANSWER(75/153)*3 + (39/153)*16 + (39/153)*0.5 = 5.6765 years
A bond has three years left until it matures, the yield to maturity on the bond is 5% and
the annual coupon rate is 6%. If the face value (par value) of the bond is $1000,
calculate the bond's duration in years. - ANSWERBond price equals 1027.23
Duration numerator is 60/1.05 + (2*60)/1.05^2 + (3*1060)/1.05^3 = 2,912.99
So duration is 2912.99/1027.23 = 2.8358 years
, A bank has DA = 2.4 years and DL= 0.9 years. The bank has total equity of $82 million
and total assets of $850 million. What is the bank's duration gap in years? -
ANSWER2.4 - 0.9035*0.9
where k = (850-82)/850 = 0.9035
Duration gap model - ANSWERincorporates the impact of interest rate changes on the
overall market value of an FI's balance sheet and ultimately on its owners' equity or net
worth
Insolvency risk - ANSWERthe result, a consequence, or an outcome of excessive
amounts of one or more of the risks taken by an FI (for example, liquidity risk, credit
risk, and interest rate risk)
If the Fed wants to slow down the economy - ANSWERit will tighten monetary policy by
taking actions that raise interest rates
If the Fed wants to stimulate the economy - ANSWERit allows interest rates to fall
Duration - ANSWERmeasures the interest rate sensitivity of an asset or liability's value
to small changes in interest rates
Effect of interest rate changes on the market value of an FI's equity or net worth (∆E)
breaks down into three effects - ANSWERLeverage-adjusted duration gap = DA - kDL.
Size of the FI.
Size of the interest rate shock
Difficulties in Applying the Duration Model to Real-World FI Balance Sheets -
ANSWERDuration matching can be costly.
Immunization is a dynamic problem.
Large interest rate changes and convexity.
True or False
Gains and losses on a futures contract must be recognized daily. - ANSWERTrue
Futures contracts are marked-to-market.
Microhedging - ANSWERusing a derivative securities contract to hedge a specific asset
or liability, basis risk involved
True or False
Writing a call option on a bond pays off if interest rates rise. - ANSWERTrue
This is true since when interest rates rise, prices go down, but by writing (selling) a call
option you benefit when prices go down (since the call option buyer will pay the call
premium and not exercise the option).
ANSWERS(RATED A+)
True or False?
A rate sensitive asset is an asset whose interest rates will be repriced or changed over
some future period. - ANSWERTrue
True or False
If a bank has a negative repricing gap, the bank is exposed to refinancing risk, or the
risk that interest rates will increase and the cost of rolling over or reborrowing funds will
be higher than the interest revenue being earned on assets. - ANSWERTrue
A bank has rate sensitive assets of $100 and rate sensitive liabilities of $70. If interest
rates increased by 1%, what would be the expected annual change in net interest
income? - ANSWER$0.30
100-70 = 30
1% x 30 = .30
A bank is facing a forecast of rising interest rates. What is the ideal repricing and
duration gap? - ANSWERPositive repricing gap and negative duration gap
A negative repricing gap is preferred when interest rates are expected to rise (interest
income will go up by more than interest expense goes up), and the negative duration
gap implies a positive relationship between changes in interst rates and changes in the
market value of the financial institution.
True or False
The higher the duration, the less sensitive the bond price is to changes in interest rates.
- ANSWERFalse
A bank has three assets. It has $75 million invested in consumer loans with a 3-year
duration, $39 million invested in T-Bonds with a 16-year duration, and $39 million in 6-
month maturity T-Bills with a 0.5-year duration. What is the duration of the bank's asset
portfolio in years? - ANSWER(75/153)*3 + (39/153)*16 + (39/153)*0.5 = 5.6765 years
A bond has three years left until it matures, the yield to maturity on the bond is 5% and
the annual coupon rate is 6%. If the face value (par value) of the bond is $1000,
calculate the bond's duration in years. - ANSWERBond price equals 1027.23
Duration numerator is 60/1.05 + (2*60)/1.05^2 + (3*1060)/1.05^3 = 2,912.99
So duration is 2912.99/1027.23 = 2.8358 years
, A bank has DA = 2.4 years and DL= 0.9 years. The bank has total equity of $82 million
and total assets of $850 million. What is the bank's duration gap in years? -
ANSWER2.4 - 0.9035*0.9
where k = (850-82)/850 = 0.9035
Duration gap model - ANSWERincorporates the impact of interest rate changes on the
overall market value of an FI's balance sheet and ultimately on its owners' equity or net
worth
Insolvency risk - ANSWERthe result, a consequence, or an outcome of excessive
amounts of one or more of the risks taken by an FI (for example, liquidity risk, credit
risk, and interest rate risk)
If the Fed wants to slow down the economy - ANSWERit will tighten monetary policy by
taking actions that raise interest rates
If the Fed wants to stimulate the economy - ANSWERit allows interest rates to fall
Duration - ANSWERmeasures the interest rate sensitivity of an asset or liability's value
to small changes in interest rates
Effect of interest rate changes on the market value of an FI's equity or net worth (∆E)
breaks down into three effects - ANSWERLeverage-adjusted duration gap = DA - kDL.
Size of the FI.
Size of the interest rate shock
Difficulties in Applying the Duration Model to Real-World FI Balance Sheets -
ANSWERDuration matching can be costly.
Immunization is a dynamic problem.
Large interest rate changes and convexity.
True or False
Gains and losses on a futures contract must be recognized daily. - ANSWERTrue
Futures contracts are marked-to-market.
Microhedging - ANSWERusing a derivative securities contract to hedge a specific asset
or liability, basis risk involved
True or False
Writing a call option on a bond pays off if interest rates rise. - ANSWERTrue
This is true since when interest rates rise, prices go down, but by writing (selling) a call
option you benefit when prices go down (since the call option buyer will pay the call
premium and not exercise the option).
