Richman Bank,, N.A., has a portfolio of loans and securities expected to generate cash inflows for the bank as follows:
Expected Cash Inflows of Principal & Interest Payments | Annual Period in Which Cash Receipts Are Expected |
| |
$1,500,675 | Current year |
746,872 | Two years from today |
341,555 | Three years from today |
62,482 | Four years from today |
9,871 | Five years from today |
Deposits and money market borrowings are expected to require the following cash outflows:
Expected Cash Outflows of Principal $ Interest Payments | Annual Period during Which Payments must be Made |
| |
$1,595,786 | Current year |
831,454 | Two years from today |
123,897 | Three years from today |
1,005 | Four years from today |
----- | Five years from today |
If the discount rate applicable to the previous cash flows is 5 percent, what is the duration of the Richman’s portfolio of earning assets and of its deposits and money market borrowings? What will happen to the bank's total returns, assuming all other factors are held constant, if interest rates rise? If interest rates fall? Given the size of the duration gap you have calculated, in what type of hedging should Richman engage? Please be specific about the hedging transactions that are needed and their expected effects.
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