Question 1
Consider a hypothetical government security dealer named Banana Republic with the following balance sheet information. Market yields are in parentheses.
a. What is the repricing gap if the planning period is 91 days?
b. What is the impact over the next 91 days on net interest income if all interest rates decrease by 25 basis points?
c. Suppose, the following one-year runoffs are expected: $20 million for two-year T-notes, and $40 million for 12-year T-bonds. What is the one-year repricing gap?
d. If runoffs are considered, what is the effect on net interest income at year-end if interest rates decrease by 25 basis points?
Question 2 (20%).
Consider a financial institution with a bond portfolio comprised of sovereign country debt that has both interest rate and exchange rate risk exposure. The duration of assets is 3.4 years and the duration of liabilities is 5.2 years. The portfolio has assets of US$18 billion (including 2.5 billion euro) and liabilities of US$16 billion (including 4.15 billion euro) with no other currencies bought or sold forward.
a. What is the interest rate risk of the bond portfolio?
b. What is the foreign exchange rate risk of the bond portfolio?
c. If there is only a 1% chance that interest rates will decline 10 basis points or more tomorrow, what is the dollar daily value at risk at the 1% level?
d. If there is only a 1% chance that US dollar/euro exchange rates will increase by at least US$0.25 per euro tomorrow, what is the daily dollar value at risk at the 1% level?
e. What is the 1% dollar VaR for both interest rate and currency risks if the correlation between the risk exposures is –0.05?
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