A commercial bank invests in a loan with a current market value of $600,000 and a maturity of 3 years. The bank partially funds the loan by issuing a zero coupon bond with a maturity (principal) value of $450,000 and a duration of 3 years. The current market rate is 7% and interest rates are expected to increase by 1%. Which of the following statements is true? (a) The current equity value of the position is $150,000 and if interest rates increase the equity value will increase. (b) The current equity value of the position is $232,666 and if interest rates increase the equity value will increase. (c) The current equity value of the position is $232,666 and if interest rates increase the equity value will decrease. (d) The current equity value of the position is $150,000 and if interest rates increase the equity value will remain the same. (e) None of the given answers. The current equity value of the position is $232,666 and if interest rates increase the equity value will remain the same as the maturity gap is 0.
Macrohedging
Hedging or hedge accounting is a risk-mitigation technique used to protect the current financial position from potential losses. Hedging is often confused with speculating. The major difference between the two is that hedging does not involve guessing, whereas speculation is based on guessing the direction of movement of the underlying asset to book profits.
Finance Mathematics
The area of applied mathematics known as mathematical finance, also known as quantitative finance or financial mathematics is concerned with the mathematical modeling of financial markets. The application of mathematical methods to financial problems is known as financial mathematics. A financial market is a place where people can exchange low-cost financial securities and derivatives. Stocks and bonds, raw materials, and precious metals, both of which are regarded as commodities in the stock markets, are examples of securities. It uses probability, statistics, stochastic processes, and economic theory as methods.
A commercial bank invests in a loan with a current market value of $600,000 and a
maturity of 3 years. The bank partially funds the loan by issuing a zero coupon bond
with a maturity (principal) value of $450,000 and a duration of 3 years. The current
market rate is 7% and interest rates are expected to increase by 1%. Which of the
following statements is true?
(a) The current equity value of the position is $150,000 and if interest rates increase the
equity value will increase.
(b) The current equity value of the position is $232,666 and if interest rates increase the
equity value will increase.
(c) The current equity value of the position is $232,666 and if interest rates increase the
equity value will decrease.
(d) The current equity value of the position is $150,000 and if interest rates increase the
equity value will remain the same.
(e) None of the given answers. The current equity value of the position is $232,666 and if
interest rates increase the equity value will remain the same as the maturity gap is 0.
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