Subject: Business / Finance
Part 2: Blue Sunday Bank has a portfolio of loans and securities as well as deposits and money market borrowings that are expected to produce the following cash inflows and outflows for the bank in the coming five years. Cash inflows are denoted with a “+” and cash outflows are denoted with a “-“.Expected cash flow (in %bodyamp;rsquo;s)Timing of cash flow+ 1.9 million1 year from today– 1.4 million1 year from today+ 750,0002 years from today– 830,0002 years from today+ 350,0003 years from today– 400,0003 years from today+ 65,0004 years from today– 45,0004 years from today+ 10,0005 years from today– 40,0005 years from todayREQUIRED (please carefully label your work so that it is clear for your instructor):Assume the current discount rate that applies to these cash flows is 4.5%. On a spreadsheet, compute the duration of the total cash inflows as well as the duration of total cash outflows and then compute the duration gap of this bank.
In your own words, explain the danger of the bank’s position. You may enter this answer in a cell within your spreadsheet.
What kind of hedging should the bank use to reduce its risk? Be specific about the hedging transaction and discuss its expected effect. Again, enter this answer in a cell within your spreadsheet.
Now assume that the bank has total assets of $30 billion and total liabilities of $25 billion and all asset and liability cash flows are proportional to the cash flows given in this problem. How much would the value of the bank change if interest rates rise from 4.5% to 5.0%? What about if interest rates changed from 4.5% to 4.2%? Assume that total assets and total liabilities have the same duration profile as the cash flows given in this problem. Show your calculations on the spreadsheet.