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    Market value of long term securities

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    The Savings and Loan (S&L) industry had an extremely difficult time during the 1980s, as interest rate levels reached new highs. The following problem illustrates the nature of these difficulties.

    i) Assume an S&L's balance sheet is as follows. While this balance sheet is obviously over-simplified, it represents an approximation of the financial condition of many S&Ls. All values represent market values.

    Assets: Liabilities and Equity:

    Mortgage Loans $1,000,000 Deposits $1,300,000

    Other Assets $600,000 Equity $300,000

    Total Assets $1,600,000 Total L&E $1,600,000

    ii) Assume the mortgage loan portfolio consists of 30-year, fixed-rate mortgages with an average interest rate of 5% per year. The present value of these mortgages (their principal) is currently $1,000,000.

    iii) Find the monthly payment for this mortgage loan portfolio, using Excel's PMT function. (HINT: Set PV = outstanding principal, NPER = the life of the mortgages (in months), and RATE = the average interest rate (per month) for the mortgage loan portfolio.) FOR THIS PORTION I USED EXCEL'S PMT FUNCTION AND ARRIVED AT $50k FOR THE PAYMENT.

    iv) Use your answer to part (iii) to determine the new market value of the mortgage loan portfolio, assuming that the market rate of interest rises to 9% per year. (HINT: Use Excel to find the PV of this portfolio, defining NPER as above, RATE = 8% per year divided by 12, and PMT = the value you obtained in part [a], problem 1) In the 1980s, actual market rates of interest rose by much more than this, with mortgage rates in the range of 12% or more uncommon. FOR THIS PORTION I USED EXCEL'S PV FUNCTION AND ARRIVED AT $6,814,714.71 THIS APPEARS TO BE HIGH AND I CANNOT FIGURE OUT WHY. I USED RATE=.0066667, NPER=360, PMT=-50,000.

    v) Calculate the decline in market value of the mortgage loan portfolio that occurred by comparing your answer in part (iv) to the value of the portfolio as revealed in the balance sheet above.BY USING MY ANSWERS ABOVE THIS WOULD APPEAR TO ME THAT THE VALUE HAS RISEN NOT DECLINE. THIS IS WHY I THINK iv ABOVE IS INCORRECT. I NEED TO BE SHOWN WHERE I MISCALCULATED.

    vi) Compare this decline in market value to the amount of equity on the S&L's balance sheet. Is the institution now insolvent? Explain.


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    Solution Preview

    iii) In this part you have taken the interest rate as 5% which is annual rate while the period is based on months and so the monthly payments are coming very high. With ...

    Solution Summary

    The solution explains how to determine the value of long term securities using excel function