1.0 Answer Question 1
Assume an immediate and sustained 1 percent across-the-board rise in interest rates. Based on a review of Exhibit 3, discuss how one would use interest rate-sensitivity gap information to estimate the impact of rising interest rates on the earnings of Norwest Corporation.
Interest sensitivity gap is used to measure how the interest change will affect the asset sensitivity and liability sensitivity. Asset sensitivity or positive gap occurs when the interest sensitive asset and interest sensitive liability is greater than zero. However, liability sensitivity incur when interest sensitive asset and interest sensitive liability is less ...view middle of the document...
01) = -$9.90 million
* 3 years to 5 years,
∆NII = ($1,194 million) (0.01) = $11.94 million
Based on the table exhibit 3 given or the calculation above, we noticed that there is “negative” values for the first three periods of Norwest Corporation. However, the following years are showing the “positive” value. When the interest rates rise, it unfortunately will affect the net income of Norwest Corporation. This means that, Norwest Corporation has face interest rate rise for first three periods. In addition, when the interest rate rises, the earning of Norwest Corporation will increase the asset sensitive due to the interest revenue generated by assets will increase more than the cost of borrowed funds. On the other hand, if the interest rates rise, the earning of Norwest Corporation will reduce the liabilities sensitive. Thus, when the interest rate rise, the net interest margin Norwest Corporation will reduce because the rising cost associated with interest sensitive liabilities will exceed the increase in interest revenue. From the above, we can says that the larger the GAP difference, the greater the impact on the earnings of Norwest Corporation.
2.0 Answer Question 2:
How Norwest determining accounting risk?
Accounting perspective is focuses on the risk reported net income over a particular time frame. Norwest determining the accounting risk with using the simulation model. Traditionally this company measure the interest risk by taken the form of the gap report which is it differences between assets and liabilities that reprise in given time periods. Why this company using this model? Simulation model its dynamic nature which is it can capture the effect of future balance sheet trends, different patterns of rate movement and changing relationships between rates. Other than that, it also can capture the effects of embedded option risk by taking into account the affects of interest rate caps floors and varying the level of prepayment rates on assets as function of interest rate. Simulation model used to determine the one and three years gap level that corresponds to the limits within which the corporation has placed earning at risk to interest rate movement.
How Norwest determining economic risk?
The economic risk is focuses on the risk to the market value of the corporation’s balance sheet, which is the net is referred to as the market value of balance sheet equity. Assessing interest rate risk in the economic perspective focuses on the risk to net worth arising from all reprising mismatches or gaps across the full maturity spectrum. Norwest using the market model to measure the interest rate risk from the economic perspective. The market value of each assets and liability is calculated by computing the present value of all cash flows generated. This model used to measure the sensitivity of the market value of equity to a wide range of interest rate changes. The process of modeling market valuation risk...