Question

1.     Consider the following Balance Sheet for Total Caribbean Bank(TCB) (in millions)

ASSETS			LIABILITIES
Floating rate mortgages	120		Demand deposits	110
(currently 12% annually)			(currently 3% annually)
30 years fixed rate loans			1 year CD	50
(currently 7% annually)	80		(currently 6% annually)
			Equity	40
	200			200

a.      What is TCB expected net interest income (NII) at year end? (1mark)

b.     What is TCB expected net interest income at year end if interest rates grew by 500 basis points. (1 mark)

c.      What is TCB expected net interest income at year end if interest rates fell by 200 basis points on assets, but decline by 4% on liabilities. (2 marks)

Answer 1

Answer to (a).

Year-End Expected Interest Income of TCB= Interest Received on Floating Rate Mortgages+Interest Received on 30 Years fixed Rate Loans

or: Year-End Expected Interest Income of TCB= Amount of Floating Rate Mortgages*Interest Rate+Amount of 30 year fixed rate loans*Interest Rate

As given in the question: Amount of Floating Rate Mortgages= $ 120 millions, Interest Rate on Floating Rate Mortgages= 12% , Amount of 30 year fixed rate loans= $ 80 millions and Interest Rate on Fixed Rate Loans= 7%

Putting these values into the above formula we get:

Year-End Expected Interest Income of TCB= $120*.12+$ 80* .07 ie. $ 20 millions

Year-End Expected Interest Expenses of TCB= Interest Paid on Demand Deposits+Interest Pain on 1 Year CD

or: Year-End Expected Interest Expenses of TCB= Amount of Demand Deposits*Interest Rate+Amount of 1 Year CD*Interest Rate

As given in the question: Amount of Demand Deposits= $ 110 millions, Interest Rate on Demand Deposits= 3% , Amount of 1 Year CD= $ 50 millions and Interest Rate on 1 Year CD= 6%

Putting these values into the above formula we get:

Year-End Expected Interest Expenses of TCB=$110*,03+$ 50*.06 ie. $ 6.3 millions

Year-End Net Interest Income of TCB= Expected Interest Income of TCB-Expected Interest Expenses of TCB

Using the values as determined above in this formula we get:

Year-End Net Interest Income of TCB= $ 20-$6.3 ie. $ 13,7 millions

Answer to (b):

Since 100 basis point is equivalent to 1% so 500 basis points will be equivalent to 5%.

So the interest rate will rise by 5%, however this will only effect the Demand Deposits and the Floating Rate Mortgages.It will not affect the fixed rate loans or the one year CDs.

So:

Year-End Expected Interest Income of TCB= Interest Received on Floating Rate Mortgages+Interest Received on 30 Years fixed Rate Loans

or: Year-End Expected Interest Income of TCB= Amount of Floating Rate Mortgages*Interest Rate+Amount of 30 year fixed rate loans*Interest Rate

All other things will remain same as Part (1) except the interest received on Floating Rate Mortgages which will now be: 12%+5% ie. 17%, so putting these into the formula we will get:

Year-End Expected Interest Income of TCB= $120*.17+ $80*.07 ie. $ 26 millions

Year-End Expected Interest Expenses of TCB= Interest Paid on Demand Deposits+Interest Pain on 1 Year CD

or: Year-End Expected Interest Expenses of TCB= Amount of Demand Deposits*Interest Rate+Amount of 1 Year CD*Interest Rate

All other things will remain same as Part (1) except the interest paid on Demand Deposits which will now be: 3%+5% ie. 8%, so putting these into the formula we will get:

Year-End Expected Interest Expenses of TCB= $110*.08+$ 50*.06 ie. $11.8 millions

Year-End Net Interest Income of TCB= Expected Interest Income of TCB-Expected Interest Expenses of TCB

Using the values as determined above we get:

Year-End Net Interest Income of TCB= $26-$11.8 ie. $ 14.2 millions

So the net interest income of TCB will rise if there is an increase by 500 basis points.

Answer to (c):

Since the interest rate fell by 200 basis points or 2% on the asset side so using the logic as described in question number 2 we have:

Year-End Expected Interest Income of TCB= Interest Received on Floating Rate Mortgages+Interest Received on 30 Years fixed Rate Loans

or: Year-End Expected Interest Income of TCB= Amount of Floating Rate Mortgages*Interest Rate+Amount of 30 year fixed rate loans*Interest Rate

All other things will remain same as Part (1) except the interest received on Floating Rate Mortgages which will now be: 12%-2% ie. 10%, so putting these into the formula we will get:

Year-End Expected Interest Income of TCB= $120*.1+$ 80*.07 ie. $17.6 millions

Now on the liabilities side the interest fell by 4% so using the same logic as described in Part (2) we get:

Year-End Expected Interest Expenses of TCB= Interest Paid on Demand Deposits+Interest Pain on 1 Year CD

or: Year-End Expected Interest Expenses of TCB= Amount of Demand Deposits*Interest Rate+Amount of 1 Year CD*Interest Rate

All other things will remain same as Part (1) except the interest paid on Demand Deposits which will now be: 3%-4% ie. -1%, so putting these into the formula we will get:

Year-End Expected Interest Expenses of TCB= -$110*.01+$ 50*.06 ie.$1.9 millions

Year-End Net Interest Income of TCB= Expected Interest Income of TCB-Expected Interest Expenses of TCB

Using the values as determined above we get:

Year-End Net Interest Income of TCB= $17.6-$1.9 ie. $ 15.7 millions

So the ent interest income will rise.