The ABC bank has $100M assets consisting of $45M 1-year 7% coupon bonds and $55M of 10 year, 12% loans. Its liabilities include $75M 1 year 5% IR CDs, $20M 2-year 6% IR CDs, and $5M equity (all figures are in market values).
a. What is the weighted average maturity of the assets?
b. What is the weighted average maturity of the liabilities?
c. What is the FI’s maturity gap
d. Draw a diagram showing how the equity value of ABC will react to changes in interest rate. Suppose a competitor bank BCD has a maturity gap of 15 years. Show the sensitivity of the equity value of the BCD Bank to the interest rate in the same diagram. Label the axes.
e. Will ABC benefit or suffer losses if interest rates decline unexpectedly? Explain.
f. How can ABC reduce its exposure to interest rate risk by changing the maturity of its assets? What are the drawbacks of this strategy?