AFW3651 Treasury ManagementMajor Assignment (30%)

Semester 2, 2010

Due date: Week 10, Friday 24th. September 2010, 4 PM

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Part 1: (15 marks) (no more than 300 words excluding calculation)

CASE STUDY: COSMO BANK

Managing Interest Rate RiskCosmo Bank started off as a medium-sized commercial bank in the late 1980s, involving mainly in conventional banking products. In recent years, the bank’s business have grown internationally and now provides a more comprehensive range of financial services that includes personal financial services, commercial banking, corporate, investment banking and markets, retail commercial lending to small and medium enterprises (SMEs) in Malaysia, private banking; and other activities.

As the global economy recovers from the subprime financial turbulence and coupled with the ongoing rising inflation rates, the management of Cosmo Bank is concern that interest rates will be further pushed upwards. The central bank has already raised overnight policy rate (OPR) twice this year after the economy expanded at the fastest pace in at least a decade to 2.5 percent. Many economists believe that given the increasing inflationary pressures, there would be at least another increase of 25 basis points this year. Some even expects an increase of between 75 basis points to 100 basis points this year backed by improving economic conditions.

If the central bank really does revise the interest rates upwards, Cosmo’s analysts forecast that it would be adjusted by 50 basis points. This adjustment would mean that all banking and financial services would experiencing a parallel repricing of basis points. However, there are some financial analysts who believe that Malaysia’s economy is likely to experience a slowdown and even contraction in the second half of 2010. If this realises, then Bank Negara may reduce the OPR by 30 basis points.

As Cosmo’s main source of funding is heavily dependent on accepting deposits, and its main source of income is dependent on giving out loans the bank’s management and board of directors are very concern that volatile interest rates may jeopardise the bank’s profitability profitability and

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soundness of the entity. At this time of uncertain interest rate movement, the real challenge for Cosmo is to maintain a balance between its large portfolio of interest sensitive financial assets and liabilities. For this reason, the bank’s board wants to monitor the bank’s position more closely.

As a consultant appointed by the bank’s board of directors, you are required to present a detailed report reviewing Cosmo’s interest rate risk exposure. The report should contain analysis on the bank’s gap and duration gap, showing how changes in interest rate can affect the bank’s net interest income and economic value of equity (EVE). Suggest to the board, what can be done to achieve an immunized portfolio such that interest rate risk can be avoided.

To perform the first part of your report, the following information is gathered:

Exhibit 1: Extraction from Cosmo Bank’s Balance Sheet

　Assets RM (bil) AverageRate (%)

　　Liabilities RM (bil)AverageRate (%)

Cash 18 - Interbank borrowings 30 ?

5-years variable rate loans

60 ?Non-interest bearing liabilities

4 -

1-year short-term investment in securities

26 7.2 1-year short-term deposits 50 1

5-years long-term investment in securities

21 7.8 Fixed deposits 60 ?

Non-interest bearing assets

2 -1-year notes and other short-term borrowings

10 4.5

10-years long-term fixed rate loans

56 ?5-years bonds and other long-term borrowings

20 5

4-years Bank Negara Bonds

1 5 Equity: Share capital 17 -

Fixed assets 15 - Reserves 8 　

Intangible assets 1 - Ret. earnings 1 -

　 200 200 　　 　 　 　　 　 　

(Assume that book value of assets and liabilities approximates its market value)

Cosmo Bank has issued two types of loans: variable rate loans and long-term fixed rate loans. The bank has a policy to maintain its loan portfolio at 70 percent as consumer loans and 30 percent as commercial loans. In addition, the bank the charges the following rates on the loans issued:

Types of loans Consumer Commercial

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Variable rate loans 7% 6%Long-term fixed rate loans 6.5% 5%

Exhibit 2: Interbank BorrowingsBorrowing period @ rates RM (billions)1 week @ 2.5% 52 weeks @ 2.8% 153 weeks @ 3% 64 weeks @ 3.2% 4

TOTAL 30

Exhibit 3: Fixed DepositsDeposit period @ rates1 month @ 2.5%3 months @ 2.6%6 months @ 2.8%1 year @ 3%3 years @ 3.2%5 years @ 3.5%

The amount of fixed deposits collected is spread equally across various maturity periods.

Part 2: (15 marks) [no more than 1700 words]

“Bank Treasury Management is basically Risk Management” Discuss.

Instructions to students

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Due date: Week 10 (by 4PM Friday, 24th September, 2010)

Submission details:Assignments should be submitted via the assignment box marked “AFW3651 Assignment Box” situated in Building 6 Level 5 by 4pm on Friday of Week 10.Students must retain a copy of the final version of their assignment at least until the unit results are finalised.

Penalties for late lodgement:A maximum penalty of 1 mark allocated to this assessment task will be deducted for each day that it is late. Assignment will not be accepted after 1st October 2010.

Return of marks:Marked assignments will be returned to students during lecture in Week 13. Students who do not attend Week 13 lecture may collect assignments from their lecturer during consultation times.

Faculty style guideWork submitted for these assessments must follow the Faculty Style as outlined in the Faculty Q Manual. Copies of this Manual can be obtained at the bookshop or on line at URL: http://www.buseco.monash.edu.au/publications/qmanual/qmanual.pdf.

Applications for extension of timeApplications for an extension of time allocated to an assessment task must be made by completing the application form found at URL. http://www.buseco.monash.edu.au/student/exams/speccon.html. The form must be submitted to the Chief Examiner for approval.

Assignment coversheetWork submitted for assessment MUST be accompanied by a completed and signed assignment coversheet, available at URL: http://www.buseco.monash.edu.au/student/forms/assessment-coversheet.doc.

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