Question

Short Answer. 2-3 sentences

1. For a bank, what is one primary disadvantage of holding more cash? (It is not inflation.)

2. What is one advantage of an earnings sensitivity analysis (NII simulation) that is not provided by a static GAP report?

3. If you invest $1,000 today in a security paying 8% compounded annually, how much will the investment be worth 40 years from today?

4. You are a bank investment officer considering buying a bond. It is a three-year bond paying an annual coupon rate of 4%, paid semi-annually. The current annual market rate of interest for similar bonds is 3%. What should the price of the bond be (par=100)?

Answer 1

#1. For a bank, most important disadvantage of holding cash is that it does not earn income. While banks source funds in the form of deposits (mostly) and borrowings, interest has to be paid. This fund is to be parked remuneratively in various financial assets viz. loans, investments etc. all these types of financial assets generate income. However, cash is another form of asset which does not generate income.

#2. Earning sensitivity analysis is the study of impact of change in one variable over that of another one. By this method, a bank or financial institution can ascertain the change in net interest income (NII). This is not available in the static gap analysis which looks into the sensitivity of assets and liabilities of various periods on re-pricing.

#3.   $1,000 invested today is worth $21,724.52 in 40 years, at 8% interest compounded annually, as follows:

#4. Price of the bond is $102.85 function of Excel as follows: