1. Below are First Bank's Assets and Liabilities:
First Bank
Assets Liabilities
Rate-Sensitive assets $20 million Rate Sensitive Liabilities $50 mill
Variable and Variable-rate CDs
Short term loans
Short term securities
Fixed-rate liabilities $50 mill
Fixed Rate Assets $80 million Chequable deposits
Reserves Savings deposits
Long-term loans Long-term CDs
Long-term securities Equity Capital
Also assume that the average duration of its assets is 2 years, that interest rates are initially at 10%, and that the bank's equity capital is $10 million.
(a) If the First Bank sells $10 million of its fixed rate assets and replaces them with ratesensitive assets, what is the income gap for the bank? What will happen to profits next year if interest rates fall by 3 percentage points?
(b) If the First bank decides to convert $5million of its fixed rate assets into rate sensitive assets, what will happen to its interest rate risk? Explain using gap analysis.
(c) What happens to the market value of the banks assets if the interest rate increases by 2 percentage points?
2. Describe the transaction the Bank of Canada makes when wanting to raise the overnight interest rate. Also outline the effects on economic activity (the way monetary policy works) when the interest rate rises.
3. For a country like Canada, a fixed exchange rate system is superior over a flexible exchange rate system. Furthermore, we should adopt a new, common currency with the U.S. and Mexico."