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Request Description

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. |

Solution Description

The Savings and Loa