Hands Insurance Company issued a $90 million, one-year zero-coupon note at 8 percent add-on annual interest (paying one coupon at the end of the year) or with an 8 percent yield. The proceeds were used to fund a $100 million, two-year commercial loan with a 10 percent coupon rate and a 10 percent yield. Immediately after these transactions were simultaneously closed, all market interest rates increased by 1.5 percent (150 basis points).
a) What is the true market value of the loan investment and the liability after the change in interest rates?
b) What impact did these changes in market value have on the market value of the FI’s equity?
c) What was the duration of the loan investment and the liability at the time of issuance?
Hands Insurance Company issued a $90 million, one-year zero-coupon note at 8 percent add-on annual interest (paying one coupon at the end of the year) or with an 8 percent yield. The proceeds were used to fund a $100 million, two-year commercial loan with a 10 percent coupon rate and a 10 percent yield. Immediately after these transactions were simultaneously closed, all market interest rates increased by 1.5 percent (150 basis points).
a) What is the true market value of the loan investment and the liability after the change in interest rates?
b) What impact did these changes in market value have on the market value of the FI’s equity?
c) What was the duration of the loan investment and the liability at the time of issuance?
Related questions
| An insurance company issued a $93 million one-year, zero-coupon note at 7 percent add-on annual interest (paying one coupon at the end of the year) and used the proceeds plus $13 million in equity to fund a $106 million face value, two-year commercial loan at 9 percent annual interest. Immediately after these transactions were (simultaneously) undertaken, all interest rates went up 1.8 percent. |
| a. | What is the market value of the insurance companyâs loan investment after the changes in interest rates? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places. (e.g., 32.16)) |
| Market value of the loan investment | $ million |
| b. | What is the duration of the loan investment when it was first issued? (Do not round intermediate calculations. Round your answer to 3 decimal places. (e.g., 32.161)) |
| Duration of the loan investment | years |
| c. | Using duration, what is the new expected value of the loan if interest rates are predicted to increase to 10.8 percent from the initial 9 percent? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places. (e.g., 32.16)) |
| New expected value | $ million |
| d. | What is the market value of the insurance companyâs $93 million liability when interest rates rise by 1.8 percent? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places. (e.g., 32.161)) |
| Market value of the liability | $ million |
| e. | What is the duration of the insurance companyâs liability when it is first issued? |
| Duration of the liability | year(s) |
| An insurance company issued a $110 million one-year, zero-coupon note at 7 percent add-on annual interest (paying one coupon at the end of the year) and used the proceeds plus $30 million in equity to fund a $140 million face value, two-year commercial loan at 9 percent annual interest. Immediately after these transactions were (simultaneously) undertaken, all interest rates went up 1.7 percent.
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| b. | What is the duration of the loan investment when it was first issued? (Do not round intermediate calculations. Round your answer to 3 decimal places.) |
| c. | Using duration, what is the new expected value of the loan if interest rates are predicted to increase to 10.7 percent from the initial 9 percent? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.) |
| d. | What is the market value of the insurance companyâs $110 million liability when interest rates rise by 1.7 percent? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.) |
