Chapter EightInterest Rate Risk IChapter OutlineIntroductionThe Central Bank and Interest Rate RiskThe Repricing Model Rate-Sensitive Assets Rate-Sensitive Liabilities Equal Changes in Rates on RSAs and RSLs Unequal Changes in Rates on RSAs and RSLsWeaknesses of the Repricing Model Market Value Effects Overaggregation The Problem of Runoffs Cash Flows from Off-Balance Sheet ActivitiesThe Maturity Model The Maturity Model with a Portfolio of Assets and LiabilitiesWeakness of the Maturity ModelSummaryAppendix 8A: Term Structure of Interest Rates Unbiased Expectations Theory Liquidity Premium Theory Market Segmentation TheorySolutions for End-of-Chapter Questions and Problems: Chapter Eight1.What was the impact on interest rates of the borrowed reserves targeting regime used by the Federal Reserve from 1982 to 1993?The volatility of interest rates was significantly lower than under the nonborrowed reserves target regime used in the three years immediately prior to 1982. Figure 8-1 indicates that both the level and volatility of interest rates declined even further after 1993 when the Fed decided that it would target primarily the fed funds rate as a guide for monetary policy.2.How has the increased level of financial market integration affected interest rates?Increased financial market integration, or globalization, increases the speed with which interest rate changes and volatility are transmitted among countries. The result of this quickening of global economic adjustment is to increase the difficulty and uncertainty faced by the Federal Reserve as it attempts to manage economic activity within the U.S. Further, because FIs have become increasingly more global in their activities, any change in interest rate levels or volatility caused by Federal Reserve actions more quickly creates additional interest rate risk issues for these companies.3.What is the repricing gap? In using this model to evaluate interest rate risk, what is meant by rate sensitivity? On what financial performance variable does the repricing model focus? Explain.The repricing gap is a measure of the difference between the dollar value of assets that will reprice and the dollar value of liabilities that will reprice within a specific time period, where reprice means the potential to receive a new interest rate. Rate sensitivity represents the time interval where repricing can occur. The model focuses on the potential changes in the net interest income variable. In effect, if interest rates change, interest income and interest expense will change as the various assets and liabilities are repriced, that is, receive new interest rates.4.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? The maturity bucket is the time window over which the dollar amounts of assets and liabilities are measured. The length of the repricing period determines which of the securities in a portfolio are rate-sensitive. The longer the repricing period, the more securities either mature or need to be repriced, and, therefore, the more the interest rate exposure. An excessively short repricing period omits consideration of the interest rate risk exposure of assets and liabilities are that repriced in the period immediately following the end of the repricing period. That is, it understates the rate sensitivity of the balance sheet. An excessively long repricing period includes many securities that are repriced at different times within the repricing period, thereby overstating the rate sensitivity of the balance sheet. 5.Calculate the repricing gap and the impact on net interest income of a 1 percent increase in interest rates for each of the following positions: Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million.Repricing gap = RSA RSL = $200 $100 million = +$100 million. DNII = ($100 million)(.01) = +$1.0 million, or $1,000,000. Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million.Repricing gap = RSA RSL = $100 $150 million = -$50 million. DNII = (-$50 million)(.01) = -$0.5 million, or -$500,000. Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million.Repricing gap = RSA RSL = $150 $140 million = +$10 million. DNII = ($10 million)(.01) = +$0.1 million, or $100,000.a.Calculate the impact on net interest income on each of the above situations assuming a 1 percent decrease in interest rates. DNII = ($100 million)(-.01) = -$1.0 million, or -$1,000,000. DNII = (-$50 million)(-.01) = +$0.5 million, or $500,000. DNII = ($10 million)(-.01) = -$0.1 million, or -$100,000.b.What conclusion can you draw about the repricing model from these results?The F