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Community Bank & Trust: Dollar Gap Analysis

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Jack Brothers had recently taken over the management of the securities portfolio at Community Bank & Trust, a $100 million asset-size bank in a suburb of a large U.S. city. Previously, Jack worked in the loan portfolio of a bank in another state. He had gained favorable recommendations from his prior employers in large part due to his innovative work in securitizing loans, a growing area of management in the banking industry involving the issuance of mortgage backed securities on home loans. A meeting with CEO George Willis the day before had raised some unsettling evidence concerning the gap management of the bank. The accounting department reported that, while the dollar gap of the bank over the past year was zero, with equal dollar holdings of interest rate sensitivity of assets and liabilities, the bank had lost $500,000 in interest income over the last year as interest rates had rapidly fallen 300 basis points. Mr. Willis asked Jack to identify the "missing gap" problem that appears to exist and make recommendations in the securities portfolio that would help solve the problem. He wanted a fast turnaround on these questions, with a preliminary report due tomorrow afternoon. He also made clear that, according to investment policy, securities portfolio management was a means to effective and efficient asset/liability management. The recommendations made by Jack to Mr. Willis would be forwarded to the Asset/Liability Management Committee in order to coordinate activities in the bank.
Jack reviewed asset/liability materials that evening in his study at home and decided to go forward with a standardized gap analysis (see Chapter 5). The short period of time allowed for the preliminary report required that only a general analysis of the problem be attempted at this stage.
In the morning he visited the accounting department staff, who helped him obtain some rough historical figures from the past year on the interest rate sensitivity of broad asset and liability accounts in response to a change of 100 basis points in the prime rate of interest.
It occurred to Jack that the rapid decline in interest rates this past year may imply that interest rates will increase in the future. Consequently, he also checked the financial newspaper in the morning and found that the two-year Treasury bond rate was 5.0 percent and the one-year Treasury rate was 4.0 percent. He estimated that approximately a 50 basis point liquidity premium likely exists in the two-year bond rate to compensate investors for the added price risk of these bonds relative to the one-year bonds.
Based on standardized gap analysis, why did the 300 basis point drop in interest rates so adversely affect the bank's net interest earnings in the past year?
How could securities management have reduced or eliminated the recent loss of $500,000?
What is the interest rate forecast using expectations and liquidity premium theories of the yield curve?
What are the implications of anticipated future interest rate movements for net interest earnings, the bank's gap position, and securities management in the near future?

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First, remember that when we say dollar gap what we mean is the difference between the amount, in US dollars, that a company earns from its investment in dollar-denominated assets and the dollar amount the company pays in interest for its dollar-denominated liabilities. This gap is also called the net interest margin.
Second, having said that, we can say therefore that effective and efficient control of the dollar gap is an important function of asset/liability management.
Third, below are the discussions for the questions:
Based on standardized gap analysis, why did the 300 basis point drop in interest rates so adversely affect the bank's net interest earnings in the past year?
Based on the analysis, it is possible that though the assets and liabilities portfolios of the bank have equal dollar ...

Solution Summary

The expert discusses dollar gap in 500+ words with short calculations explained. The dollar gap is provided.

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Global Economics in Mexico after NAFTA

Scenario: Acme Automotive is one of the major US producers of automobiles in Mexico. You have been sent to the Acme automotive plant in Nuevo Laredo, Tamaulipas, Mexico as the new Operations Manager to respond to recent declines in employee morale, productivity, and cost effectiveness at the Nuevo Laredo plant in the past 12 months. Talk of union organizing is of utmost concern to your supervisor in terms of short run and long run costs of production. Your job is to investigate the productivity/cost effectiveness problem and make recommendations to top management for goals and strategies in line with the Acme Vision.

Your first day at the job, you receive the following letter from a disgruntled employee:

(Note- the 'Maquiladoras' to which the writer refers, is the word for companies that process Mexico-imported components, then export them.)

Dear Sir:

I've been working in Maquiladoras since I was 20 years old, and now I'm 27. I've gotten more and more worried, because my job is ruining my health and I have no way out.

Now I work at Acme, where I've been for about a month and a half. "You could say it's forced labor, considering how the foremen talk to the workers and how much psychological pressure they put on people. We work an average of 14-15 hours a day. There's no transport service to and from work, and we get off the shift at 4 o'clock in the morning. Usually we have to wait until 7 AM before we can catch a public bus. And when a bus does come, getting home costs 20 pesos. That makes a very big dent in your take-home pay - 380 to 400 pesos a week ($40-43).

My job is bending steel cables...which are about a centimeter thick, and I have to bend about 3500 a day. Because of what's passing through my hands every day, I can hardly sleep at night - the pain is so bad. Then I have to get up in the morning to do it again. In the future, I know that I can get carpal tunnel problems, which is a very scary idea. I've asked to change to another position, but no one wants to change because whoever works in this job gets a lot of pain in his wrists.

I feel that in three or four years my hands are going to be useless. I've been thinking that I'll have to get another job. What else can I do? They say work in the Maquiladoras is the best paid work here in the city. But there's not much difference from one factory to another.

This is all just normal - the standard. Really, I'm living my whole life in the factory. Because of the time and money pressure, I have no ability to develop myself even as a worker, much less as a human being."

After I had been working in Acme for a month, I went to my supervisor with my concerns about health and safety problems at the plant. He told me that I was putting the Maquiladora workers in danger by making waves. I know that the company's goal is to cut production costs and increase the profits from the engines we produce, but I am hoping you will consider the plight of the poor Mexican workers. I am hoping you will see through our eyes as well as from the eyes of the company officials.

Yours truly,

Enrique Santiago

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***Deliverable Length: 4-5 pages, proper APA formatting, list all reference cited sources.

Details: You are laying the groundwork for Acme's deployment of key lead operations managers and top level personnel to international manufacturing plants. As such, one expectation the company has for you is that you will research and write relevant economic white papers for the pre-orientation of future deployed employees.

Write a 4-5 page white paper which will help employees understand the economic experience of Mexico since NAFTA. Issues you may want to cover include, but are not limited to, trade liberalization, national sovereignty, worker rights, World Trade Organization and committees, relationship with World Bank and IMF, types of economic development.

References:

World Bank Group. Global development finance 2001. Retrieved January 7, 2004, from http://www.worldbank.org/prospects/gdf2001/vol1.htm

World Bank Group. (2001). Mexico - A comprehensive development agenda for the new era. Retrieved January 7, 2004, from http://wbln0018.worldbank.org/External/lac/lac.nsf/Publications/9364AB8A25BABD6085256A4C004B3963?OpenDocument

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