Question 1. (10 marks)

WQF Bank has assets of $3 million invested in a 30-year, 10 percent semi-annual coupon Treasury Bond selling at par. The duration of this bond has been estimated at 7 years. The assets are financed with equity and a $750000, two-year, 8 percent semi-annual coupon capital note selling at par.

a. What is the leverage adjusted duration gap of WQF Bank? (3 marks)

b. What is the impact on equity value if the relative change in all market interest rates is a decrease of 25 basis points? Note: The relative change in interest rates is ΔR/(1+R/2) = –0.0025. (2 marks)

c. Using the information calculated in parts (a) and (b), what can be said about the  desired  duration  gap  for  a  financial  institution  if  interest  rates  are expected to increase or decrease? (2 marks)

d. Verify your answer to part (c) by calculating the change in the market value of equity assuming that the relative change in all market interest rates is an increase of 20 basis points. (2 marks)

e. What would the duration of the assets need to be to immunise the equity from changes in market interest rates? (1 mark)

Question 2. (10 marks)

a. Using regression analysis on historical loan losses, a bank has estimated the following:

XC = 0.005 + 0.7XL and

XH = 0.008 + 1.9XL

where XC = loss rate in the business sector

XH = loss rate in the consumer (household) sector

XL = loss rate for its total loan portfolio

i. If the bank’s total loan loss rates increase by 20 percent, what are the increases in the expected loss rates in the business and consumer sectors? (1 mark)

ii. In  which  sector  should  the  bank  limit  its  loans,  and  why? (2 marks)

b. The following table shows the allocation of the loan portfolio to different sectors for BNM Bank and LRT Bank:

Calculate loan allocation deviation from national benchmark both for BNM Bank and LRT Bank. Explain which bank deviates significantly from the national benchmark. (7 marks)

Question 3. (10 marks)

You can obtain a loan of $200000 at a rate of 15 percent for two years. You have a choice of (i) paying the interest (15 percent) each year and the total principal at the end of the second year or (ii) amortising the loan, that is, paying interest (15 percent) and principal in equal payments each year. The loan is priced at par.

a.        What is the duration of the loan under both methods of payment? (8 marks)

b.        Explain the difference in the two results. (2 marks)

Question 4. (10 marks)

a. “In bringing securities to the market, investment bankers take clients through a three-step process” – Explain. (3 marks)

b. If you use only duration to immunise your portfolio, what three factors affect changes  in  the  net worth  of a  financial  institution  when  interest  rates change? (3 marks)

c. “Until recently, the manner in which bank failures have been resolved meant both large and small depositors were often fully protected against losses” .

Is the above statement TRUE or FALSE? How can you relate the above statement to bank regulations including capital adequacy requirement and deposit insurance? (4 marks)

Question 5. (10 marks)

a. MMR Ltd is a private company that has developed a range of innovative software packages over the past five years. The company is considering seeking admission and quotation on a stock exchange. List and briefly explain the advantages to the company of a public listing. (6 marks)