The following is an FI's balance sheet ($millions). Notes to Balance Sheet: Munis are 2-year 6 percent annual coupon municipal notes selling at par. Loans are floating rates, repriced quarterly. Spot discount yields for 91-day Treasury bills are 3.75 percent. GICs are 1-year pure discount certificates of deposit paying 4.75 percent.
What will be the impact, if any, on the market value of the bank's equity if all interest rates increase by 75 basis points?

Question

The following is an FI's balance sheet ($millions).  Notes to Balance Sheet: Munis are 2-year 6 percent annual coupon municipal notes selling at par. Loans are floating rates, repriced quarterly. Spot discount yields for 91-day Treasury bills are 3.75 percent. GICs are 1-year pure discount certificates of deposit paying 4.75 percent.
What will be the impact, if any, on the market value of the bank's equity if all interest rates increase by 75 basis points?

Quizplus · Accepted Answer

When interest rates increase by 75 basis points, the value of the fixed-rate securities will decrease in value as their rates become relatively less attractive, leading to a decrease in the market value of equity. The market value of equity will decrease by the sum of the changes in the fair value of securities, loans, and GICs, which equals $426,825 ($157,500 + $233,325 + $36,000). The decrease in the value of the munis and GICs is straightforward, while the decrease in the value of loans is more complex, involving the calculation of income lost due to a decline in income rates.

The Following Is an FI's Balance Sheet ($Millions)