Question

Consider the following balance sheet for Watchover Savings Inc. (in millions):

Assets Liabilities and Equity

Floating-rate mortgages (currently 12% p.a.) $ 70 Now deposits (currently 8% p.a.) $ 110

30-year fixed-rate loans (currently 9% p.a.) 95 5-year time deposits (currently 8% p.a.) 21

Equity 34

Total $ 165 Total $ 165

a. What is Watchover’s expected net interest income at year-end? (Enter your answer in millions rounded to 2 decimal places. (e.g., 32.16))

b. What will be the net interest income at year-end if interest rates rise by 1 percent? (Enter your answer in millions rounded to 2 decimal places. (e.g., 32.16))

c. Using the one-year cumulative repricing gap model, what is the change in the expected net interest income for a 1 percent increase in interest rates? (Negative amount should be indicated by a minus sign. Enter your answer in millions rounded to 2 decimal places. (e.g., 3

Answer 1

Net Interest Income= Interest earned on interest-earning assets - Interest paid on interest-bearing liabilities

a. What is Watchover’s expected net interest income at year-end?

Current expected interest income: $70m(.12) + $95m(.09) = $16.95m.

Expected interest expense: $110m(.08) + $21m(.08) = $10.48m.

Expected net interest income: $16.95m - $10.48m = $6.47m.

b. What will be the net interest income at year-end if interest rates rise by 1 percent?

Current expected interest income: $70m(.13) + $95m(.09) = $17.65m.

Expected interest expense: $110m(.09) + $21m(.08) = $11.58m.

Expected net interest income: $17.65m - $11.58m = $6.07m.

c. Using the one-year cumulative repricing gap model, what is the change in the expected net interest income for a 1 percent increase in interest rates?

Watchover's repricing or funding gap is $70m - $110m = -$40m.

The change in net interest income using the funding gap model is (-$40m)(.01) = -$.4m.