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Hints: Think about prepayment, refinancing options for loans and when they are exercised (i.e. if rate increases or decreases) and how does it affect rate sensitivity of loans.

Think about prepayment, refinancing options for loans

1.    Ch-7 chapter end problem 11 (Textbook page no. 278). It goes like following…An embedded option associated with each……. (

Hints: Think about prepayment, refinancing options for loans and when they are exercised (i.e. if rate increases or decreases) and how does it affect rate sensitivity of loans. Usually, rate sensitivity of an instrument increases as the probability of exercising an embedded option increases.

For deposits, think similarly about withdrawal options at the right of depositors. Cap is an option that sets the max rate for a floating rate loan. It’s an option at the right of the borrower. That means borrower benefits from exercising the option. Think about when a Cap will be exercised.

2.    Ch-7 chapter end problem 14 (Textbook page no. 278). It goes like following……Interpret the following earnings-at-risk data……

Hints: Assume Earnings-at-Risk as percentage change in Net Interest Income.

Net interest income is calculated as Interest income from assets minus interest expenses for liabilities. Now think, If 1% increase (fall) in interest rate increases (decreases) Net interest income in 1 year and more in 2 years, what does it convey about the bank’s rate sensitivity of assets/liabilities? Is the bank asset sensitive or liability sensitive? -1% yield curve inversion means that long term rates will fall relative to short term rates by 1%. Here, 2-year rate will fall relative to 1-year rate. Again, think in the same way. What do the changes net interest income in different interest rate scenarios convey about the bank bank’s risk exposure. Overall, you have to decide if the bank is asset sensitive or liability sensitive?

3.    Ch-10 chapter end problem 11 (Textbook page no. 407) . It goes like following….Use the following information to estimate marginal cost of issuing a $1 million

Hints: Check the Ch-10 Measuring the cost of fund slides. You will find the equation to calculate marginal cost of liability there. Please note, here the CD does not have any float and reserve so the Net investable balance (the denominator in the equation) will be 100%.

4.    Ch-10 chapter end problem 12  (Textbook page no. 407). It goes like following…..The weight marginal cost of funds is use in pricing……..

Hints: Think about default risk premium. Check the Ch-10 Measuring the cost of fund slides.

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