| 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. |
| 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 |
| a. 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. |
| b. 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.) |
| c. 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 = 9% per year |
| divided by 12, and PMT = the value you obtained in part iii) 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. |
| d. 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. |
| e. Compare this decline in market value to the amount of equity on the S&L's balance sheet. Is the institution now insolvent? Explain. |
Time
500.xlsx
