CFA Institute CFA-Level-III Exam - Topic 2 Question 4 Discussion

HAS TWO PARTS Tom Groh is the President of Opportunity Banks. Opportunity has historically operated in the northeastern United States, with most of its business in Maryland, Delaware, and New Jersey. Opportunity has been in business since 1987 and has built its business on making mortgages and construction loans to residential developers. Opportunity has been very profitable, because developers value the services the bank provides. This allows Opportunity to price their construction loans with higher interest rates. Opportunity services and retains ownership of the its loans. It historically has had a near-zero leverage-adjusted duration gap. In the most recent fiscal year, Opportunity has experienced important changes in their business as follows:

1. Due to pressure from local activists, Opportunity has stepped up lending in low-income areas.

Groh expects the default rate on these loans to be higher than the Loans currently in their portfolio.

2. Opportunity has bought a regional bank with operations in North Carolina, South Carolina, and Georgia. The acquired bank's loan portfolio consists mostly of commercial loans to small, local businesses.

3. A recent downturn in interest rates has caused many of Opportunity's variable rate mortgages to be refinanced to 15 and 30-year fixed-rate mortgages. Opportunity has retained the business of most of its customers who have refinanced.

a. In each of the scenarios provided, determine one effect on the investment objectives, constraints, or investment policies of the bank's security portfolio. Evaluate each scenario in isolation from the others.