BUS307-Commercial Banking Analyses - Accounting & Finance Assignment Help

Assignment Task

Task 

QUESTION 1 
    
Use this balance sheet information to answer the following questions:

The bank is considering approving a special loan with the following characteristics:
Loan A: The loan that has 4 years to maturity and has bond-like repayments. 
Loan B: The loan has repayments of $123.25 at the end of year 1, $575.25 at the end of year 4, $29.25 at the end of year 5 and $34.125 at the end of year 6.
Both loans are trading at par and the yield to maturity is 4.5 percent per annum.
Select the loan that bank should approve. Please provide justification. Assume that both loans have similar default risk.
Assuming a flat yield curve and a parallel shift of the entire yield curve of 50-basis points upward what is the impact on the FI’s market value of equity? 

Euro CDs - $1,500 - $1,200 = $300

QUESTION 1b 

Calculate the convexity for a three-year 4.5% coupon rate with a face value of $500,000 loan with amortised payments? 
Use this information to determine the impact on the market value of the amortised loan if the entire yield curve shifted downward 50-basis points. 
What is the usefulness of convexity when duration is available as a measure of interest rate risk? What is the practical implication for the three-year loan in this example?

The sensitivity of a bond's duration to changes in yield is measured by its convexity, which measures the sensitivity of a bond's duration to changes in yield. Duration is an inaccurate but quick technique of calculating a bond's price change since it implies that the change is linear when it is really sloping or "convex." If the duration of a bond increases as the yield decreases, it is said to have positive convexity. 

In this example, the market value of the loan will increase by 1.38% (2 d.p) if the yield curve shifted downward by 0.5% / 50 basis points.

QUESTION 2a 

In corporate finance the leverage ratio can be calculated by dividing capital by book value of assets. How have regulators altered this ratio to determine the capital adequacy requirements for banks or authorized depositor institutions? Compare Gorajek and Turner (2010)  analyses to those presented in Lange et al. (2015), Chapter 18. In your discussion consider the tension between the bank and the regulators.

QUESTION 2b 

What is a maturity bucket in the repricing model? Why is the length of time selected for repricing assets and liabilities important when using the repricing model? How does this impact runoff?

The maturity bucket is the time period used to calculate the monetary values of assets and liabilities. Which assets in a portfolio are rate-sensitive is determined by the duration of the repricing period. The longer the repricing period, the more assets will mature or be repriced, and hence the interest rate risk exposure will be greater. A repricing term that is too short ignores the interest rate risk exposure of assets and liabilities that are repriced in the period immediately after the repricing period ends. That is, it understates the balance sheet's rate sensitivity. An overly extended repricing period comprises a large number of securities that are repriced at different periods during the repricing period, overstating the balance sheet's rate sensitivity.

Rate sensitivity is assessed over a period of time called a maturity bucket. Because the assets and liabilities inside a maturity bucket may not have the same maturities because it may be biased towards the beginning or end, the length of time is essential. Portfolio runoff is a term used in portfolio management to indicate when assets fall in value. Runoff can happen for a variety of reasons, including the maturity or expiration of securities, the liquidation of certain assets, or any other circumstance in which assets are reduced or removed from a portfolio. 

QUESTION 3a 
Data sourced from Ifess (Integrated Fasttime Equity System) has given the following swap rates. Think of these swap rates as spot interest rates.

QUESTION 3b
A financial institution has the following balance:

QUESTION 4a 

Some members of the accounting profession are advocating market value accounting for banks.
Explain the arguments for and against market-value accounting. In your answer ensure that you clearly explain “real losses” and “paper losses” and the role of moral hazard in the application of market value accounting. Use a simplified bank balance sheet to illustrate your response.

For all stakeholders, market valuations provide a more realistic view of the bank's present financial condition. Stakeholders can understand the implications of interest rate fluctuations on the bank's equity more quickly, and they can assess the liquidation value of a troubled bank more precisely. Market values can be difficult to determine, especially for small banks with non-traded assets, which is one of the arguments against market value accounting. The rising use of asset securitization as a way of determining value of even thinly traded assets refutes this notion. Furthermore, some believe that using market value accounting might cause bank earnings to be more volatile. A key concern in this regard is that, under the FDICIA's fast corrective action requirements, regulators may shut a bank too quickly. Unrealized gains and losses are the same as paper earnings and losses. The profit only lives in the ledger of the investor (or corporate entity), and it will do so until the asset holdings are closed off and settled in real money. Paper profits or losses only become real or actual money profits/losses when an investment is sold. Some profits and losses may be merely accounting artifacts. Portfolio valuations, for example, may be based on accounting rules that employ market value accounting to describe unrealized gains and losses.

The risk that a party did not enter into a contract in good faith or supplied false information regarding its assets, obligations, or credit capacity is known as moral hazard. Moral hazard may also refer to a party's motive to take extraordinary risks in a desperate attempt to make a profit before the contract expires. Moral risks can arise at any time when two people reach an agreement with one another. Each party to a contract may have a vested interest in behaving in violation of the agreement's principles. Moral hazard arises when assets are unusually inflated due to certain reason making it seem more profitable and/or valuable than it actually is, misleading stakeholders about its true worth. This is because there exist asymmetric information where one party to a transaction has greater material knowledge than the other party. 

ABC Bank bought a building worth $100,000 as at 31 December 2020 and funded that purchase with 50?bt and 50% equity. However, in January 2021, an epidemic hit the country. Businesses were closing down and citizen started to leave. The country’s economy went into a downward spiral and the value of its land were dramatically reduced, by at least 60%. But because ABC Bank uses book value accounting in its business operations, its company is still valuing the building at $100,000. This would give stakeholders a false impression that the company is more valuable than it actually is. To be more precise, the bank should revaluate and and revaluation reserves should decrease by the same amount the building worth was decreased.

QUESTION 4b 

The risk sharing argument for the existence of loan commitments suggests that borrowers, who are more risk averse than the banks, pay the banks to bear part of the interest rate risk. Explain

QUESTION 4b 

State Bank has the following year-end balance sheet (in millions of dollars

The loans primarily are fixed-rate, medium-term loans, while the deposits are either short-term or variable-rate deposits. Rising interest rates have caused the failure of a key industrial company and, as a result, 3 per cent of the loans are considered to be uncollectable and thus have no economic value. One-third of these uncollectable loans will be charged off. 
(i) What is the impact on the balance sheet after the necessary adjustments are made according to book value accounting? 
(ii) According to market value accounting? 
(iii) How will the impact of rising interest rates be incorporated in the analysis?

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