Please note: this is only a revision sheet and you will be assessed on the exercises done and the

material covered in the PowerPoints.

CLO 3
1. New Day Bank plans to launch a new deposit campaign next week in hopes of bringing in from
$100 million to $600 million in new deposit money, which it expects to invest at a 4.25 percent
yield. Management believes that an offer rate on new deposits of 2 percent would attract $100
million in new deposits and rollover funds. To attract $200 million, the bank would probably be
forced to offer 2.25 percent. New Day’s forecast suggests that $300 million might be available at
2.50 percent, $400 million at 2.75 percent, $500 million at 3.00 percent, and $600 million at 3.25
percent. What volume of deposits should the institution try to attract to ensure that marginal
cost does not exceed marginal revenue?

Expected Rate Total Marginal Marginal Marginal Exp. Diff. Total

Inflows Offered Interest Interest Cost Rate Revenue In Marg. Profits
on New Cost Cost Rate Rev and Earned
Funds Costs
$100 2.00% 2.00 2.00 2.00% 4.25% +2.25% $2.25
$200 2.25% 4.50 2.50 2.50% 4.25% +1.75% $4.00
$300 2.50% 7.50 3.00 3.00% 4.25% +1.25% $5.25
$400 2.75% 11.00 3.50 3.50% 4.25% +0.75% $6.00
$500 3.00% 15.00 4.00 4.00% 4.25% +0.25% $6.25
$600 3.25% 19.50 4.50 4.50% 4.25% −0.25% $6.00

The marginal revenue rate is greater than the marginal cost rate up to $500 million in new
deposits. At $600 million, the marginal cost rate of 4.50 percent is greater than the marginal
revenue rate of 4.25 percent. Therefore, New Day Bank should try and attract $500 million in
new deposits.

2. R&R Savings Bank finds that its basic transaction account, which requires a $1,000 minimum
balance, costs this savings bank an average of $3.25 per month in servicing costs (including labor
and computer time) and $1.25 per month in overhead expenses. The savings bank also tries to
build in a $0.50 per month profit margin on these accounts. What monthly fee should the bank
charge each customer?

Further analysis of customer accounts reveals that for each $100 above the $1,000 minimum in
average balance maintained in its transaction accounts, R&R Savings saves about 5 percent in
operating expenses with each account. (Note: If the bank saves about 5 percent in operating
expenses for each $100 held in balances above the $1,000 minimum, then a customer
maintaining an average monthly balance of $1,500 should save the bank 25 percent in operating
costs.) For a customer who consistently maintains an average balance of $1,200 per month, how
much should the bank charge in order to protect its profit margin?
Following the cost-plus-profit approach, the monthly fee to be charged by the bank should be:

Unit price charged = Operating + Estimated overhead + Planned profit

 expense per unit margin from
the customer for expense allocated to the
of deposit each service
each deposit service deposit-service function
service unit sold

= $3.25 + $1.25 + $0.50 = $5.00 per month.

The appropriate fee for a customer maintaining an average balance of $1,200 per month would
be:

[$3.25 – {0.10 × ($3.25)}] + $1.25 + $0.50 = $2.925 + $1.25 + $0.50 = $4.675 per month.

3. Use the APY formula required by the Truth in Savings Act for the following calculation. Suppose
that a customer holds a savings deposit in a savings bank for a year. The balance in the account
stood at $2,000 for 180 days and $100 for the remaining days in the year. If the Savings bank
paid this depositor $8.50 in interest earnings for the year, what APY did this customer receive?

The average account balance is:

The formula to find the APY is:

In this instance,

APY = 0.82 percent.

CLO4
4. The cumulative interest rate gap of Poquoson Savings Bank increases 60 percent from
an initial figure of $25 million. If market interest rates rise by 25 percent from an initial
level of 3 percent, what changes will occur in this thrift’s net interest income?

New net interest income = New market interest rate × Increase in assets
= 3.75 percent × $40 million = $1.5 million
Initial net interest income = Initial market interest rate × Initial assets
= 3 percent × $25 million = $0.75 million
Percent change in net interest income = ($1.5 million – $0.75 million)/ $0.75 million
= 100 percent
Thus, the bank's net interest income will increase by 100 percent.

5. Jupiter Savings Bank currently has the following interest-sensitive assets and liabilities
on its balance sheet with the interest-rate sensitivity weights noted.

Rate Sensitivity
Interest-Sensitive Assets $ Amount Index
Federal fund loans 70.00 1.20
Security holdings 80.00 1.10
Loans and leases 425.00 1.25
Interest-Sensitive Rate Sensitivity
Liabilities $ Amount Index
Interest-bearing deposits 410.00 0.85
Money-market borrowings 90.00 0.90

What is the bank’s current interest-sensitive gap? Adjusting for these various interest
rate sensitivity weights what is the bank’s weighted interest-sensitive gap? Suppose the
federal funds interest rate increases or decreases 25 basis points. How will the bank’s
net interest income be affected (a) given its current balance sheet makeup and (b)
reflecting its weighted balance sheet adjusted for the foregoing rate-sensitivity indexes?
Dollar IS = ISA - = ($70 + $80 + $425) − ($410 + = $75
Gap ISL $90)
Weighted IS GAP = ((1.20 x $70) + (1.10 x $80) + (1.25 X $425)) – ((0.85 x $410) +
(0.90 x $90))
= $703.25 - $429.50
= $273.75
a. Change in Bank’s Income = IS Gap × Change in interest rates
= ($75) (0.0025) = $0.1875 million
Using the regular IS Gap; net income will change by plus or minus $187,500
b. Change in Bank’s Income = Weighted IS Gap × Change in interest rates
= ($273.75) (0.0025) = $0.684375
Using the weighted IS Gap; net income will change by plus or minus $684,375.
 6. If nowman's average asset duration is 1.6515 years and average liability duration is
1.5223 years. If total assets are $20 billion and total liabilities are $18 billion.

Calculate Snowman’ has a leverage-adjusted duration gap.

What will be the effect on Snowman’s networth if interest rates increase from 4.25 to
4.75 percent?
What will be the effect on Snowman’s networth if interest rates fall from 4.25 percent to
3.5 percent?

1.6515 – 1.52234657 × = 0.1163

The change in Snowman's net worth would be calculated as:

Change in Value of Net Worth =

If interest rates increase from 4.25 to 4.75 percent, change in net worth will be:

1.5223
23

= − 0.0319 billion

There is a decrease in the net worth of Snowman with the increase in the interest rate.

If interest rates fall from 4.25 percent to 3.5 percent, change in net worth will be:

1.5223
23

= + 0.0478 billion.

When the interest rates fall, Snowman’s net worth will increase.

7. Carter National Bank holds $15 million in government bonds having a duration of 12
years. If interest rates suddenly rise from 6 percent to 7 percent, what percentage
change should occur in the bonds’ market price?

The percentage change in market price is computed as follows:

Therefore, the market price will change approximately by 11.32 percent.

 8. Ocean View State Bank estimates that over the next 24 hours the following cash inflows and
outflows will occur (all figures in millions of dollars):

Deposit withdrawals $100 Sales of bank assets $ 40

Deposit inflows 95 Stockholder dividend payments 150
Revenues from sale of nondeposit
Scheduled loan repayments 90 services 95
Acceptable loan requests 60 Repayments of bank borrowings 60
Borrowings from the money
market 80 Operating expenses 50

What is this bank’s projected net liquidity position in the next 24 hours? From what sources can
the bank cover its liquidity needs?

Deposit withdrawals $100 −

Deposit inflows $95 +
Scheduled loan repayments $90 +
Acceptable loan requests $60 −
Borrowings from the money market $80 +
Sales of bank assets $40 +
Stockholder dividend payments $150 −
Revenues from sale of nondeposit
services $95 +
Repayment of bank borrowings $60 −
Operating expenses $50 −

= [$95 + $90 + $80 + $40 + $95] − [$100 + $60 + $150 + $60 + $50]
= 400 − 420
= −$20 million.

Faced with an expected liquidity deficit, Ocean View State Bank could arrange to increase its
money market borrowings from other institutions or sell some of its assets or do some of both.

9. Suppose Abigail Savings Bank's liquidity manager estimates that the bank will experience a $375
million liquidity deficit next month with a probability of 15 percent, a $200 million liquidity
deficit with a probability of 35 percent, a $100 million liquidity surplus with a probability of 35
percent, and a $250 million liquidity surplus bearing a probability of 15 percent. What is this
savings bank’s expected liquidity requirement? What should management do?

Liquidity Deficits or Associated

Surpluses Probabilities
-$375 million 15 percent
-$200 million 35 percent
 +$100 million 35 percent
+$250 million 15 percent
100 percent

The bank's expected liquidity requirement is:

Expected Liquidity Requirement = 0.15 × (-$375 million) + 0.35 × (-$200 million) +
0.35× (+$100 million) + 0.15 × (+$250 million)
= -$56.25 million - $70 million + $35 million + $37.5 million
= -$53.75 million

Faced with an expected liquidity deficit the bank's liquidity manager must still begin preparing
for meeting the institution's cash needs through arranging for credit lines or deposits from other
banks and actual or potential deposit customers and strengthening the bank's liquid asset
position.