A financial intermediary has the following balance sheet (in millions) with all assets and liabilities in market values:
Assets Liabilities and Equity
6 percent semi-annual 4-year 5 percent 2-year subordinated debt
Treasury-notes (par value $12) $10 (par value $25) $20
7 percent annual 3-yr.
AA-rated bonds (par=$15) $15
9 percent annual 5-yr
BBB rated bonds (par=$15) $15 Equity capital $20
Total Assets $40 Total Liabilities & Equity $40
- Under FASB Statement No. 115, what would be the effect on equity capital (net worth) if interest rates increase by 30 basis points? The T-notes are held for trading purposes, the rest are all classified as held to maturity.
Under FASB Statement No. 115, how are the changes in the market value of assets adjusted in the income statements and balance sheets of FIs?
- Under FASB Statement No. 115, what would be the effect on equity capital (net worth) if interest rates increase by 30 basis points? The T-notes are held for trading purposes, the rest are all classified as held to maturity.
Only assets that are classified for trading purposes or available-for-sale are to be reported at market values. Those classified as held-to-maturity are reported at book values. The change in value of the T-notes for a 30 basis points change in interest rates is:
$10 = PVAn=8,k=?($0.36) + PVn=8,k=?($12) Þ k = 5.6465 x 2 = 11.293%
If k =11.293% + 0.30% =11.593/2 = 5.7965%, the value of the notes will decline to:
PVAn=8,k=5.7965($0.36) + PVn=3,k=5.7965($12) = $9.8992. And the change in value is $9.8992 – $10 = -0.1008 x $1,000,000 = $100,770.39
The remainder of the balance sheet remains the same:
6% semi-annual 4-year 5% 2-year subordinated debt
T-notes (par value $12) $9.8992 (par value $25) $20.0000 7% annual 3-yr.
AA-rated bonds (par=$15) $15.0000 Equity capital $20.0000
9% annual 5-yr
BBB rated bonds (par=$15) $15.0000 Adj. To equity -0.1008
Total $39.8992 $39.8992
- Under FASB Statement No. 115, how are the changes in the market value of assets adjusted in the income statements and balance sheets of FIs?
Under FASB Statement No. 115 assets held till maturity will be kept in book value. Assets available for sale and for trading purposes will always be reported in market values except by securities firms, which will have all assets and liabilities reported in market values. Also, all unrealized and realized income gains and losses will be reflected in both income statements and balance sheets for trading purposes. Adjustments to assets available for sale will be reflected only through equity adjustments.
