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Dgap Calculation

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5.1 What is asset-liability management?

Asset/liability management is the coordinated management of the entire portfolio of a financial institution. It considers both the acquisition of funds from various sources and the allocation of funds to profitable investments. The traditional focus of ALM has been on net interest income. However, it also considers market values, via duration. Finally, simulations allow other aspects of risk management to be brought into the ALM process.

5.1 Given the following information:
Assets $ Rate Liabs & Equity $ Rate
RSA $3,000 10.0% RSL $2,000 8.0%
NonRSA 1,500 9.0 NonRSL 2,000 7.0
Nonearning500 Equity 1,000 $5,000 $5,000

a. Calculate …show more content…

Calculate the duration of this balance sheet.
b. Assuming that the required rate of return is 8%, what would be the effect on the bank’s net worth if interest rates increased by 1%.
c. Suppose that the expected change in net worth is unacceptable to management. What outcome could management take to reduce this change?

a. The duration of assets is as follows: = ($220/$1000) (.5 years) + ($700/$1000) (8 years) = 0.110 + 5.60 = 5.71 years

The duration of liabilities is: = ($560/$830) (.5 years) + ($270/$830) (2.5 years) = 0.337 + 0.813 = 1.15 years

The duration gap is:
DGAP = DA – W (DL). [Where W = TL/TA (830/1000)]

= 5.71 years – (.83) (1.15 years) = 5.71 - .95 = 4.76 years

b. The change in net worth would be:

% Change in Net Worth = - DGap (change in i / 1+i)

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Net worth would decline by 4.41%

In dollar terms:
$ Change in Net Worth = -DGAP (change in i / 1+i) x TA = - 4.41% x $1000 = - $44.10

c. The bank could alter the duration of its assets and liabilities. Specifically, it could shorten the duration of assets and lengthen the duration of liabilities.

If we wanted to immunize

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