Management of Financial Institutions 3505. Sample M1 Fall 2014
Practice Questions (NOTE: The exam may be more challenging)
(Present the formulas you are using and show the details of your work. Write legibly).
1. The Mellon open-end fund, with 1,000,000 shares outstanding, has the following assets in its portfolio: 200,000 shares of P&G currently priced at $75, and 250,000 shares of Intel currently prices at $95, and 300,000 shares of Microsoft currently priced at $80. The Carnegie closed-end fund has the following stocks in its portfolio: 200,000 shares of REITs priced at $5 and $1B of real estate and 30-year mortgages. It has a total of 500,000 shares ...view middle of the document...
Mellon is an open-ended fund. It can issue new shares and the price of each share will equal NAV/share.
Carnegie is a close-ended fund. It has a fixed # shares which are traded in the market. The share price may differ from NAV/share depending on the forces of demand and supply of the shares.
Mellon is a smaller fund with a smaller share price.
• Mellon is a stock fund, Carnegie is a sector fund (real estate)
2. 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?
2. a. MA = .45 x 1 + .55 x 10 = 5.95
b. ML = (75/95) x 1 + (20/95) x 2 = 1.21
c. MGAP = 5.95 - 1.21 = 4.74
d. See diagram. This is the case of borrowing short and lending long.
If maturity gap is 15 years (much wider than this bank), the line will be much steeper.
If IR rise, ABC will suffer because it borrows short and lends long.
ABC can reduce its exposure by narrowing its maturity gap; increase its RSA and decrease its RSL. The difficulty is to actually achieve these goals as the customers of the banks may want the opposite.
3. Use the following information about a hypothetical government securities dealer to answer the questions below:
Assets (market values) Liabilities (market values)
$150 million 30 day TB $575 million 14 day repos
$275 million 91 day TB $290 million 1 year commercial paper
$350 million 2 year Treasury notes
$90 million 180 day municipal notes
a. Calculate the dealer’s maturity gap. Assume 360 days in a year.
b. How can the dealer reduce the interest rate exposure of its portfolio? Be specific.
MA = (1/865) [150 x30 + 275 x 91 + 350 x 720 + 90 x 180]/360 = .96
• ML = (1/865) [575 x 14 + 290 x 360]/ 360 = 8050/311400 + 290/865 = .025 + .333 = .36
• Mgap = MA – ML =.96 - .36 = .60
b. increase RSA (hold shorter term and variable rate assets) and reduce RSL (hold longer term and fixed rate liabilities).
Multiple Choice: Key
EBEEB EDEDA BBEAE DEDAB
CEDCD BCABB DBECD ED