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Problem Set #3 (Ch. 12-13)

Please type where possible. You need to show your calculations to get full credit.

Chapter 12

1. A bank has issued a one-year certificate of deposit for $50 million at an interest rate of 2 percent. With the proceeds, the bank has purchased a two-year Treasury note that pays 4 percent interest. What risk does the bank face in entering into these transactions?  What would happen if all interest rates were to rise by 1 percent? Show your calculations. (5 Points)

2.  Consider the balance sheets of Fulton Bank and Bank of America.  If both banks have equal access to the interbank market and funds from the Federal Reserve, which bank do you think faces the greatest liquidity risk? Which bank do you think is at the greatest risk of insolvency? Explain your answer and show your calculations. (5 Points)

3. Suppose a bank faces a gap of -20 between its interest-sensitive assets and its interest-sensitive liabilities. What would happen to bank profits if interest rates were to fall by 1 percentage point? You should report your answer in terms of the change in profit per $100 in assets. (5 Points) 

4. If lines of credit and other off-balance sheet activities do not, by definition, directly affect the balance sheet, how can they influence the level of liquidity risk to which the bank is exposed? (5 Points)

Chapter 13

5. Suppose you have a defined-contribution pension plan.  As you go through your working life, in what order would you choose to have the following portfolio allocations: (a) 100% bonds and money-market instruments, (b) 100% stocks, (c) 50% bonds and 50% stocks? (5 Points)