FIN 4100 Management of Financial Institutions Fall 2019 Assignment 3 – duration gap analysis and credit risk analysis Do this assignment individually. 1. Calculate the duration of the following loans...

Please do it on excel


FIN 4100 Management of Financial Institutions Fall 2019 Assignment 3 – duration gap analysis and credit risk analysis Do this assignment individually. 1. Calculate the duration of the following loans (please indicate if you make any additional assumptions): a. An interest only loan with a maturity of 7 years that pays an annual coupon of 6% and has a 5.875% yield to maturity. b. A 12-year zero coupon loan. c. A 4-year amortized loan with an interest rate of 3.75% with quarterly payments and a 4.625% yield to maturity. 2. Glacier Bank has $12.06 billion in total assets, $11.21 billion of which are financial assets. Its liabilities (all financial) are $10.41 billion. Assuming the financial assets have a duration of 5.95 years and the duration of the liabilities is 2.25 years. a. What is the bank’s duration gap? b. What is its leverage adjusted duration gap? c. What is the expected change in equity value (in $ and %) if interest rates which are currently 4.07% increase by 30 basis points? d. What is the expected change in equity value (in $ and %) if interest rates which are currently 4.07% decrease by 25 basis points? For questions 3-6, use the following information: Base rate 5.5% Credit risk premium 3% Origination fees 0.35% Compensating balance 7.5% Reserve requirement 10% Probability of payment 98.25% Expected recovery in event of default 55% 3. What is the contractually promised return (the contract rate) on the loan? 4a. How does the answer to question 3 change if all values from question 2 are the same except the base rate is 2% higher? b. How does the answer to question 3 change if all values from question 2 are the same except the credit risk premium is 1% higher? c. How does the answer to question 3 change if all values from question 2 are the same except the origination fee is doubled? d. How does the answer to question 3 change if all values from question 2 are the same except the compensating balance is 2.5% higher? e. How does the answer to question 3 change if all values from question 2 are the same except the reserve requirement is 2.5% lower? 5a. What is the expected return on the loan from question 3 if the lender expects no recovery if the loan defaults? b. What is the expected return on the loan from part a of this question if the probability of payment is 1% lower? 6a. What is the expected return on the loan from question 3 if the expected recovery in the event of default is as indicated above? b. What is the expected return on the loan from part a of this question if the expected recovery rate is 10% greater than indicated above? 7. Find the following from the most recent annual financial statements for a publicly traded company of your choice: a. the ratio of net working capital to total assets, x1 b. the ratio of retained earnings to total assets, x2 c. the ratio of earnings before interest and taxes to total assets, x3 d. the ratio of market value of equity to book value of long term debt, x4 (be sure that you adjust as necessary if book value is stated in thousands of dollars and equity value, in dollars). e. the ratio of sales to total assets, x5. 8a. Using the ratios from question 10, compute the Altman Z score for the company. (The Z score equation is Z = 1.2 x1 + 1.4 x2 + 3.3 x3 +0.6 x4 +1.0 x5). b. Explain what it indicates about the company’s risk of default. 9. A proposed loan of $8m has total annual interest rate 5.875% and fees of 0.25%. The loan’s duration is 6.14 years. The lender’s cost of funds is 5.525%. Comparable loans have a yield of 5.875%. The expected maximum change in the loan rate due to a change in the credit risk premium for the loan is 0.85%. (This value is based on actual change in credit risk premium for the worst 1% of comparable loans over some prior period.) a. What is the risk adjusted return on capital (RAROC) on this loan? b. If the lender requires RAROC to exceed 25%, how could the terms of the loan be changed to make this loan acceptable? 10a. If the expected default rate on a credit card is 8.5% and the risk-free rate is 3.25%, what interest rate must a financial institution charge on the credit card in order for its expected return to equal the risk-free rate? If the financial institution assumes a 0% recovery rate in the event of default, what interest rate will the financial institution charge? b. If the expected default rate on a 1-year home equity loan is 2.5% and the financial institution expects to recover 75% of the total loan return in the event of default, what rate must a financial institution charge on the automobile loan in order for its expected return to equal the risk free rate of 3.25%? 11. Assume that the company you selected in question 8 has a loan equal to 23% of its market capitalization that must be repaid in 5 years. If the risk-free interest rate is 1.75% and the standard deviation of returns on the company’s stock is 0.325, what is the probability the company will default on the loan?