ANSWER KEY

MGF 661:

Multiple choices:

1. D2. A3. A4. D5. B

6. C7. D8. D9. B10. A

Problems:

1.a IS gap = IS Assets-IS liabilities = (500+50+750)-(300+500) =$1300-800 = $500 million

b. IS ratio = IS Assets/ IS liabilities = 1300/800

= 1.63

c. If interest rates rise by 0.5% Change in net interest income= IS gap*change in interest rate

=$500*0.005 =$2.5 million increase

2.a $100,000,000*0.01*(30/360) =$83,333.33

b. $100,000,000*0.0125*(30/360) =$104,166.67

Increase interest expense for bank = $ 20,833.34

c. i) Short hedge

ii) $100,000,000*0.96*(30/360) = $8,000,000 $100,000,000*0.948*(30/360) = $7,900,000 Gain on hedge = $100,000

iii) Net overall gain or loss $100,000-$20,833.34 = $79,166.66 Gain

3.a Loss on sale of bonds$10,000,000-$9,750,000 = $250,000 Loss

Tax impact:$2,50,000*0.30 =$75,000 Tax benefit

b. Net effect this yearOld bonds $10,000,000*0.05 = $500,000 InterestNew bonds $10,000,000*0.06 = $ 600,000 InterestInterest income increase $100,000

Net effect: $75,000 Tax benefit+ $100,000 Increase interest income $175,000 Higher earnings