Question

Consider the following balance sheet for ABC Inc( in millions)

Assets	Liabilities and Equity
Floating Rate loans ( currently 6% annually) = $80	Demand Deposits(currently at 1% annually) = $30
20 year fixed rate loans ( currently 5% annually) = $20	Time Deposits( currently at 6% annually) = $60
Total Assets = $100	Equity = $10
	Total Liabilities and Equity = $100

a) What is ABC's expected net interest income at year end?

b) What will be the net interest income at year end if interest rates rise by 100 basis points?

c) Using the cumulative IS Gap model, what is the expected net interest income for a 1 percent increase in interest rates?

d) Comparing b and c what do you observe?

Answer 1

a) calculating expected net interest income

Expected Net Interest income = interest income-interest expenses

therefore, expected interest income= 80*.06 +20*.05 = 5.8 (mn $)

expected expenses = 30*.01+60*.06=1.08 (mn $)

so expected net interest income = 5.8-1.08=4.72 (mn $)

b) Since interest rate is rising by 100bps, so it will affect only floating rate. fixed will remain same

therefore, expected net interest income = (80*.07+20*.05)-(30*.02+60*.06) = 2.4 (mn $)

c) repricing gap can be calculated by subtracting liabilities from assets in floating rate section-

therefore, repricing gap = 80-30 = 50

so change in income after 1 % increase in interest rates = 50 *.01 = 0.5

therefore there is a change of 0.5 (mn $)

d) there is drastic difference while comparing the results of Points B & C.

B says there will be change of 2.32 mn dollars however C identifies change of 0.5 mn dollar only. there is a difference of 1.82 when we compare both the methods.