Problem:
A bank has two 3-year commercial loans with a present value of $70 million. The first is a $30 million loan that requires a single payment of $37.8 million in three years, with no other payments till then. The second loan is for $40 million. It requires an annual interest payment of $3.6 million. The principal of $40 million is due in three years.
Required:
Question 1: What is the duration of the bank's commercial loan portfolio?
Question 2: What will happen to the value of its portfolio if the general level of the interest rates increases from 8% to 8.5%
Note: Provide support for your rationale.