A bank’s economic department has just forecast accelerated growth in the economy with GDP expected to grow at a 4.5 percent annual growth rate for at least the next two years. What are the implications of this economic forecast for an investment officer? What types of securities should the officer

Question

A bank’s economic department has just forecast accelerated growth in the economy with GDP expected to grow at a 4.5 percent annual growth rate for at least the next two years. What are the implications of this economic forecast for an investment officer? What types of securities should the officer think most seriously about adding to the investment portfolio? Why? Suppose the bank holds a security portfolio similar to that described in Table 10-3 for all insured U.S. banks. Which type of securities might the investments officer want to think seriously about selling if the projected economic expansion takes place? What losses might occur and how could these losses be minimized?

Accepted Answer

This economic forecast suggests that the current yield curve should be upward sloping and that interest rates will rise over the next two years. In addition, loan demand should increase as the economy expands suggesting that the bank may have to sell some of its investment portfolio in the future to meet that demand. The investment officer would probably shorten the maturities of the investment portfolio. An exception to this might be if the investment officer wants to ride the yield curve by selling shorter term securities at a premium today and replacing them with longer maturity securities with higher coupon rates. However, the investment manager must take into account the risk of capital losses for the future with this strategy. The investment manager can reduce his risks with the appropriate hedging tools as discussed in previous chapters.

Question 10.P.11: A bank’s economic department has just forecast accelerated g...

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