Essay by v0504University, Bachelor's September 2007

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Executive SummaryAustralia Bank's interest rate exposure can be calculated using two different models which are the duration model and the PVBP model. Based on the information provided, the duration, modified duration and duration gap of its assets and liabilities are determined. The impact on the market value of equity due to a 1% increase in interest rates is also assessed. This is then compared with the PVBP model.

An assessment of Australia Bank's Value at Risk and Daily Earnings at Risk was also carried out using one-year historical data from 3rd January 1995 to 2nd January 1996.

As managers of the bank, we have also assessed the interest rate risk for the bank if the central bank was going to increase the overnight cash market interest rate in the near future using futures contracts, forward rate agreements, options and swaps.

Question 1a)The Duration and Modified Duration of the assets subject to interest rate risk(see Appendix 1 for details)Duration of AssetsDurationMarket ValueD*MVLoansFixed Housing 1.9076,543,000145,066,072.95Business

Loans30 days 0.0815,890,0001,318,870.0090 days 0.2517,635,0004,408,750.00180 days 0.5024,932,00012,466,000.002 years (semi annual) 1.9127,759,00053,003,000.235 years (semi annual) 4.3615,245,00066,448,905.1710 years (semi annual) 7.2312,596,00091,069,407.59Liquid AssetsGovernment Securities180 days 0.5029,310,00014,655,000.002 years (semi annual) 1.9134,567,00065,925,923.195 years (semi annual) 4.3835,000,000153,409,438.35Short Term SecuritiesOther Bank Bill 6 months 0.5026,626,00013,313,000.00316,103,000621,084,367.48Average Duration of AssetsDA = Total D*MV/Total Market Value =1.964816428Modified Duration of AssetsDmod = D/(1+r/f)LoansFixed Housing Loan 1.864826573Business Loans30 days 0.08296404990 days 0.249016385180 days 0.4920775512 years (semi annual) 1.8787747345 years (semi annual) 4.28882647910 years (semi annual) 7.11406672Liquid AssetsGovernment Securities180 days 0.4920775512 years (semi annual) 1.8766038585 years (semi annual) 4.312827718Short Term SecuritiesOther Bank Bill 6 months 0.492077551b)The Duration and Modified Duration of the liabilities subject to interest rate risk(see Appendix 2 for details)Duration of LiabilitiesDurationMarket ValueD*MVLong Term Liabilities2 years Semi-annual 1.9635,241,00068994093.685 years Semi-annual4.3922,235,00097584166.3710 years Semi-annual 7.8410,716,00084064168.78Current LiabilitiesShort Term Deposits1 month (30 days)0.0880,523,0006683409.003 months (90 days)0.2586,641,00021660250.006 months (180 days)0.5082,987,00041493500.00318,343,000320479587.83Average Duration of LiabilitiesDL...