1a)

There are 3 popular business model for banking financial institutions

includes retail-funding, wholesale funding and market oriented with
the focus on trading. The classification of business model depends
on their shares of loan, wholesale funding and trading activities
associated with inter-banking lending. ANZ business model is toward
retail-funding and whole-sale funding business model comparing to
trading. This is because their major liability (84%) comprises of
deposits from customers and wholesale funding including debt
insurances and subordinated debt which are then lent to their
customer. More specifically, the bank inclines toward retail-funding
debt from customer deposit more than wholesale funding as 82%
their deposit fund are from retail customer deposit. Therefore, this
can be illustrated that the business model of the bank relies mostly
from stable funding sources including customers deposit such as
term deposit or CDs. As a result, the business model possesses
stable profitability and efficiency through out the period as they
have the least volatility. Besides the transformation of fund services,
the bank also provides insurance, superannuation and funds
management service to expand their economic of scale and
economic of scope functions. Their major customers include
residential home loans, credit cards and overdrafts associated with
corporate and institutional customers. Therefore, their revenue flows
come from 3 main sources which are net interest income (net of
interest income and interest expense), net fee and commission
income (income from sales, trading and risk management activities)
and net funds management and insurance income from provision of
investment, insurance and superannuation funds.
b)
The following profit ratio, assets and liabilities are taken from the
consolidated features as profits from the whole group can show the
potential for diversification and the benefit of economic of scale and
scope comparing to only the individual company associated with
eliminating intergroup income to reflect a true and fair view of
profit.
Regarding profitability, profit margin of the company increases
significantly and steadily from 29.5% in 2010 to 37.2% in 2015.
Year
2014
2013
2012
2011
2010
PM
37.2%
35%
32.73%
32.5%
29.5%

Despite there was a decrease in net interest margin from 2010 to

2014 from 2.47% to 2.13%, there was an significant increase in
profit from $4.5m to $7.3 in 2014. To illustrate this contradiction,
there has been an expansion of the business explained by their
increment in assets and liability especially loans and deposit.
Moreover, since there was a reduction in cash rate thus in order to
attract more deposit to meet the demand for loans, the bank must
suffer some interest rate burden on the liability side in order to
attack their customers given the low interest environment. In
addition, operating expense has been decreasing comparing to
operating income from 46.5% in 2014 to 43.7% reflecting efficiency
business as a result of economic of scale. There was also a slightly
increment in other incomes especially in non-interest services such
as fee and commissions and foreign exchanges reflecting the
benefits of economic of scope. However, the company needs to
consider their net interest margin as their increment in profit mostly
comes from the expansion of business which is not organic growth
thus better negotiation regarding interest spread would benefit the
company in the long-term.
The asset of the company increases significantly through out the
year from $531.739 bn to $772.092 bn in 2014 or 45.2% with the
growth of loans and advance. This can be illustrated by the fact that
the company has developed and increase their operation to meet
the demands of customers. This is because the cash rate from RBA
has gradually decreased over the years to implement expansionary
monetary policy to stimulate customer spending and business
expansion thus the needs for loans increased strongly through out
the year with the reduction of cash rate from 4.75% in 2010 to 2.5%
in 2014 down by nearly half. In term of increment in loans and
advance, there were significant increase in terms loan with 33.9%
from 2010 to $271,388m in 2014 in housing term loans and an
escalation of 74% from $122,584m in 2010 in non-housing term
loans reflecting the demand for real estate and mortgage of
customers. In addition, there was a dramatic decrease in hire
purchase from $10,351m in 2010 to $2,238m in 2014 indicating that
the company has moved their concentration from hire purchase to
terms loan. Along with an increment in loans and advance, trading
securities also grows significantly by 48% to $49,692m in 2014
especially in liquid securities such as local, semi-government
securities and other securities which yield low return. The set aside
of capital would be potentially required by the RBA in order to avoid
crisis and negative externality effect from the defaults of other

banks. However, these assets yield low return and may be an

opportunity cost for the bank.
Similar to asset, liability of the company has also increased
significantly through the period from $497,548m to $722,808 or
45.2% especially with a strong escalation of retail deposit wholesale
funding. In term of deposit, due to the reliance on stable fund,
customer deposits have been increasing strongly from $265,988m
to $418,221 in 2014 or 57.23% while wholesale fund only increased
by 28.3%. As mentioned earlier, the bank is heading toward retailfunding business model thus they are trying to search for solid
source of fund to avoid the liquidity risk of sudden withdrawal. In
addition, customer deposit from international source has been
increasing dramatically from 2010 from $46,610m in 2010 to
$182,701m in 2014 or nearly 4 times. This can be illustrated as the
bank wants to diversify their risks and expand their business thus
offshore funding has been increasing to meet that demand. On the
contrary, deposits sourced from Australia are fairly stable through
out the period but have a sign of gradually decrease as international
deposit increases. Regarding wholesale funding, there was a slightly
increase in bonds and notes or debt issuances with an increase of
$20,904m and interbank lending also increases by $18,710m
representing a 29% and 87% respectively. This shows that the bank
has relied more on interbank lending in case of shortfall liquidity.
Regarding off-balance sheet activities, there are 2 major categories :
financial guarantee and derivative instrument. Firstly, in regarding
to financial guarantee, according note 43 on the financial statement,
the total financial guarantee of the group in 2014 is $40,075
increased 45.8% from 2010 figures. Standby letter of credit is the
obligation of the bank to pay the third party in case the accountable
party defaults on a financial obligation or performance contract.
Therefore, by entering in these contracts, the bank has to face
credit risk from the accountable party as if they default the bank has
the obligation to pay the 3rd party resulting in a liability in the
balance sheet. As a result, there are some inherent risks as well
including liquidity risk, capital risk, interest rate risk and legal risk.
Additionally, the bank also provides letter of guarantee for
subsidiary within the group resulting in obligation to pay creditors if
the subsidiary defaults. There are also the warranties provision for
Grindlays business that the bank sold to Standard Chartered Bank
(SCB) in 2000 resulted potential liability in the future in relation to
those businesses.

For derivative financial instrument, the bank has entered into

various contracts in order to hedge their risks associated with
trading and the derivative instruments are recognized as asset or
liability depending on their favorable or unfavorable moves in the
market in relation to the terms of the contract. Therefore, those
derivatives are also subjects to market risks including interest rate
risk, credit risk, currency risk and commodity risk and any
ramifications are then recognized on the balance sheet. Firstly, in
regarding to foreign exchange contract, the notion amount being
used to hedge exchange risk has increased by 3.4 times from
$475,394m in 2010 with the concentration on spot, forward and
swap agreements. These contracts are designed to hedge the
foreign risk exposure from the consolidation operation of the group
by taking position in the same currency as the currency being
hedged. The net of foreign derivative contract in 2014 is positive
comparing to 2010 illustrating that the bank has been more
appropriate at using foreign swap agreement to hedge their risk and
meet the demand of customer to hedge their own risks. In term of
commodity contract, there was an increase of $12,891 or 61% from
2010 figures but the amount of these contracts and their value
recognized are insignificant comparing to other derivatives. These
contracts are designed to hedge against a commodity risk where a
change in price would decline the value of commodities of the ANZ
commodity subsidiary associated with meeting their customers
demand. In term of interest rate contract, there was a big change in
the notion amount from 2010 to 2014 with an over 2 times
increment to $3,135,626 and the largest notion amount of the
banks derivative instruments. The mot noticeable contract is
interest swap agreement where the notion amount increases by
nearly 2.5 times from 2010 to $2,837,264. These contracts and
foreign currency swap contracts are designed to hedge the change
in fair value or cash flow of asset or liabilities arise from a change in
interest rate and exchange rate and the results of the hedge will be
recognized in the income statement. Therefore, a movement in
market that impacts negatively the hedge items would have positive
impact on the hedge instrument so the gain offset the loss of hedge
items. Sine 2010, the bank has well managed the hedging
instruments as there is only small difference between gain and loss
of hedge items and hedge instrument through the period. Unlike
other derivative contracts, there was a decrease in the notion
amount of credit defaults swap purchased from 24m to 18m. This
would be likely due to the fact that the financial market has been

strengthened comparing to post GFC 2010 thus there is less need

for credit default swap on the bank side. For the same reason, the
negative value for the credit defaults swap sold in 2010 is far bigger
than the value in 2014 due to the weak credit in 2010. Overall, the
bank has been more actively engage in derivative contracts to
hedge their risk comparing to 2010.
In regarding to book value of capital, the shareholders equity has
increased through out the period from $34,155m to $49,284m in
2014 or 44.3% increase with the focus on ordinary capital and an
increased in retained earning comparing to 2010. The number of
shares issued has slightly increased from 2010 of 2,560,162,425
shares to 2,756,627,771 shares in 2014 mostly due to dividend
reinvestment plan, options plans, bonus options plan and employee
shares acquisition plans. Dividend investment plan is considered
beneficial to the bank as it allows the bank to have an extra funding
source or internal cash flow for higher dividend, share buyback or
managing liquidity risk. In addition, ANZ also starts to buy back their
share since 2013 with $425m and $500m in 2013 and 2014
respectively signaling managements confidence regarding future
earning.
In relation to the market value of capital, the share price at the
closing of the financial year is $30.92 from the on-market share
buyback price thus the market value of the bank is 30.92*
2,756,627,771 = $85,235m comparing to $60,614m in 2010. From
this, it can be illustrated that while the book value only increases by
approximately $15m, the market value of capital increases by
$24.7m thus enlarging the gap between the book and market value.
While the book value reflects the original amount of capital raised
by the share issued and the current performance earning, the
market value may reflect a more fair value of the capital and signal
regarding future performance of the bank but subject to external
factors. Therefore, investors need to consider the market value in
order to examine their potential when investing in the bank while
keep an eye for book value in case there is a risk of defaults and
whether the bank can pay out dividend with their current profit.
c)
There are five significant risks that impact the bank. Firstly, since
the bank relies on various sources funding and lending to numerous
types of customers there would be a mismatch between duration
and repricing gap of the asset and liability thus exposing the bank to

interest rate risk. More specifically, since the bank is leaning toward
short-term retail deposits which is short duration and lending to
long-term customers, institution which is long duration. As a result,
the bank has negative repricing gap in the short-term period and
positive duration. By having a negative short term repricing gap
exposes the bank to an interest increase which would decreases net
interest income due to refinancing risks. In addition, having a
positive duration expose the bank to decrease in interest rate where
the market value of equity would decrease.
Secondly, the bank is facing liquidity risk which is the risk that the
bank can not meet its payment as it falls due such as customer
deposit or wholesale maturity. The risk comes from various sources
such as off-balance sheet activities, inherent from bank operation,
negative externality and inability to refinance due to credit rating
and market conditions. Specifically, off-balance sheet activities such
as undrawn facilities or financial guarantee can be drawn down if
contingent events happen such as defaults of accountable party
leading to the banks obligation to pay the guarantee letter thus
expose the bank to liquidity risk. BY the nature of the bank
operation, the bank would desire to lend all their available cash in
order to achieve the best return thus exposing to liquidity risk where
there are sudden demand of withdrawal. This is enhanced by the
negative externality when the default of another financial institution
has the negative impact on all the financial market.
Next, credit is another crucial risk that impacts the performance of
the bank. Credit risk is the risk that customers or counter party of
the bank fail to perform the term of the loan contract. The risk arises
from the nature of lending business and is enhanced by the
concentration of credit risk where numerous customers expose to a
homogenous factor thus subjecting to same risk of default.
Therefore, if there are unfavorable economic conditions such as
natural disaster could result in the inability to fulfill customer
obligation to the bank and lead to credit risk. In addition, with
customers in tourism, agriculture industry, there is a currency risk
that could lead them to default and thus increasing credit risk.
Lastly, the most important factor that can lead to credit risk is the
insufficient assessment of customer credit approval thus lending to
customers that are unable to pay thus the bank needs to carefully
consider the credit of customer before making the transactions.

Next, foreign exchange rate is also crucial to the international

operation of the bank. Foreign exchange rate risk is the risk that
there is the appreciation of Australia/New Zealand dollar on the long
position of denomination foreign currency or the depreciation of the
Australia/New Zealand dollar on the short position of denomination
foreign currency. The risks arise from the engagement in foreign
business by the bank without proper hedging foreign risk such as
foreign swap payment. In addition, the bank also engages in trading
position in foreign market especially in hence strengthen the
exposure of foreign risk.
Lastly, operation risk is an internal risk such as people, system and
internal process that could severely affect the process of the bank.
The risk arise from various factors such as internal fraud such as
collusion between employees, employee practices and workplace
safety such as discrimination, client products and business practices
such as misuse of customer information and internal system failure
to operate. In addition, technology risk is also lead to operation risk
where an implement of new technology can not well operate and
save cost as expected or corrupt the current data. Another aspect of
operation risk include information scrutiny and this could be a
failure of operational system if the information is used for
unauthorized purpose. As a result, a failure to manage operation risk
can significantly affect the financial performance and potential
reputation of the bank.
2a)
In order to calculate the bank duration, firstly asset duration and
liability duration have to be computed. Firstly, regarding asset, cash,
settlement balance and collateral are liquid asset and payback on
demand thus their duration is assumed to be 0. Regarding trading
securities, the duration of commonwealth securities with semicoupon payment are calculated as table below with assumption:
Date
Accummulat
Settlmen Maturi Coup
ed
Dura
#
t date
ty
on
YTM Price price($m)
tion
4/15/2
4.50 3.65 104.
1
9/30/14
0
%
%
23
1,879 4.88
4/21/2
2.75 4.23 88.4
2
9/30/14
4
%
%
6
1,960 8.27
4/21/2
4.75 4.30 104.
3
9/30/14
7
%
%
33
1,503 9.48
6/15/1
4.75 2.75 103.
4
9/30/14
6
%
%
31
996 1.64

6,338

6.51

Next, the semi-government securities and other securities duration

with higher YTM reflecting the risk comparing to commonwealth
securities are calculated as table below also with semi-coupon
payment and assumption:
Accumulat
Settlem
Maturi Coup
ed Price
Durati
#
ent date ty
on
YTM Price ($m)
on
4/22/1
4.31 99.2
1
9/30/14
7
4%
%
5
4352
2.42
6/17/2
5.50 4.76 103.
2
9/30/14
0
%
%
66
6457
4.92
5/15/2
5.25 7.56 88.1
3
9/30/14
1
%
%
2
2789
5.49
7/15/2
6.23 98.5
4
9/30/14
2
6%
%
9
5409
6.25
4/21/2
3.25 3.74 94.5
5
9/30/14
9
%
%
4
2341
11.44
8/20/3
5.75 7.45 84.3
6
9/30/14
0
%
%
1
1425
10.03
4/21/3
5.25 6.51 86.5
7
9/30/14
3
%
%
4
1524
11.24
8/21/3
3.25 81.1
8
9/30/14
5
2%
%
5
405
16.63
24702
6.33
The rest of trading securities is assumed to be equity securities
which is insignificantly impacted by interest rate change thus is
assumed to have a duration of 0. Thus the duration of the trading
securities is [6.33*24702+6.51*6338 +0*18652)/(49692)= 3.98
Next, the available for sale assets are similar to trading securities
are calculated as below reflecting maturity date according to note
12 of financial report and excluding equity securities as they are
assumed to have 0 duration:

#
1
2
3
4
5
6
7
8
9
10
11
12

Duration of available for sale asset is (3.71*18077+0*12840)/30917

= 2.17 years. Duration of regulatory deposit is the assumed to be 0
as this deposit is required by law to lodge in with central bank as
conditional for ability to carry business and their value is not
impacted by interest rate.
Next is the net loans and advance including various types of loans.
Since overdraft and credit card are similar in characteristics thus
they are combined to calculate duration as the following table. It is
assumed that credit cards are on their low interest rate type of
13.01% same with overdraft and the balance over 5 years has the
average maturity of 7 years:
Term
Amount Duration
Less than 1
1 year
7261
0.5
2 2 years
4235
1.89
3 3 years
3436
2.71
4 4 years
2295
3.46
5 More than 5
2842
5.44

years
20069
An example of calculating duration of 2 years term is set as follow
and since the overdraft with less than 1 year term the principle is
paid with interest thus their duration is their maturity and is
assumed to be 0.5 thus duration of overdraft and credit card is :
(7261*0.5+4235*1.89+3436*2.71+2295*3.46+2842*5.44)/
(20069)=2.21
The payment is discount at WACC calculated as follow with
assumption that market value of deb is equal the book value, cost of
equity is calculated using CAPM model with risk premium is 7.5%,
beta is 1.33 obtained from Yahoo! Finance and risk free is according
to treasury 10 years at 2.53%. In addition, cost of debt equal
interest expense divided by total debt value and tax rate is 29.86%.
Market
value($m
Attribute
WACC
)
Cost
to WACC
Equity
85,235
0.1251
0.0155
Debt
603,782
0.0260
0.0160
WACC=
0.0315
Next in net loan and advance is term loan- housing with the terms
various from 1 year to 10 years with different rates according to
their website charge. It is assumed that those payments will be fixed
interest rate and monthly payment thus the duration of term is
calculated as follow:
Terms
Amount
Duration
1 Year 113,785
0.98
2 Years
75,670
1.91
3 Years
55,618
2.80
4 Years
48,566
3.64
5 Years
34,678
4.49
7 Years
63,954
5.65
10 Years
92,441
7.52
Their average duration is thus : 3.72 years. Since hire purchase,
lease receivable and commercial bill have similar stream of payment
thus they would be group together and assume payment are semi
annual and fixed rate payment with 7.63% interest p.a and the
terms between 1 and 5 years have 3 year maturity on average:
Terms
Amount Duration
1 Year
3,939
0.98

1 to 5
years
15,231
2.76
Their duration is : 2.39 years. The rest of assets are not impacted by
the interest rate so their durations are 0. Next, on the liability side,
regarding deposit and other borrowing, the duration is calculated
with the assumption that fixed interest payment are made semiannual for deposit more than 6 months term with interest rate of
1.92% according to ANZ website. The amount within the time bucket
is following note 31,33 of the bank financial statement with most of
the amounts are less than 3 months maturity and those are
assumed to have average maturity of 1.5 months and since they are
less than 6 months, their duration is equal their maturity since
interest are paid with principle. In addition, the deposits with in 3
months to 12 months are assumed to have maturity of 0.75 year
and 1 to 5 years is 3 years maturity assumption:
Amount
($m)

Terms
Duration
Less than 3
months
419,903
0.125
3 to 12
months
68,959
0.748
1 to 5 years
21,217
2.93
Average duration : D = 0.33 years
Similar to deposit, long-term including subordinated debt and debt
issuances are grouped together and the terms according to note 31
with the interest rate of Bank bill rake + margin = 2.6%+3.4% = 6%
as in 30 September 2014 and the payment is half-yearly:
Terms
Amount Duration
Less than 3
months
4630
0.125
3->12months
12469
0.743
1 to 5 years
61917
2.8
After 5 years
20118
5.93
No specific day
17.66666
(perpetual)
1097
667
Perpetual duration is equal 1+0.06/0.06=17.66 years thus their
average duration is 3.21 years. Next is derivative instrument, since
the value showed on the balance sheet are their fair value
recognized at the current interest rate, the true amount exposing to
risk is actually the notional amount of the derivative contract. It is
assumed that $1,700,111m of the notional amount is derivative
asset (decrease equity value when interest increases or long
position) and the rest are derivative liability( decrease equity value
when interest decreases or short position). In addition, since their

term are less than 3 months, it is assumed that there is no payment

until maturity and thus duration is equal maturity of the contract
and is assumed to be 1.5 months. The rest of the liability has
duration of less than 3 months and are unlikely to be impacted by
interest such as policyholder liability, liability for acceptances hence
their duration is assumed to be 0. Therefore, we have the duration
of asset and liability as follow:
Asset
Amount Duration Liability
Amount Duration
Trading securities
49692
3.98 Deposit
510079
0.33
Asset available for
Long term
sale
30917
2.17 Debt
100231
3.21
Overdraft and
Derivative
credit card
20069
2.21 liability
1733938
0.125
484,712
Term Loan
3.72 Total
2344248
0.30
CB,Lease,Hire
19,170
2.39
Derivative asset
1700111
0.125
Total
2304671
1.03
So asset has duration of 1.03 years and liability has duration of 0.3
year. Their adjusted gap is thus : 1.03-k*0.3 =
1.03*2344248/2304671*0.3 = 0.72 years thus the equity value
expose to increase increasing. This is significantly less than the
duration without the derivative instrument of 2.76 years (separate
calculation) showing that with derivative instrument, the expose of
interest of the bank is less significant illustrating their hedging
purpose.
b) Given the relative change in interest rate of -0.0075, the value of
asset, liability and equity would change as follow :
Interest
rate
Change in
Duration change
Size
value(Sm)
Asset
1.03
-0.0075 2304671
17780.07
Liability
0.30
-0.0075 2344248
5301.07
Equity
12478.99
c) Realistically, given a relative change in cash rate of -0.0075, the
equity change is not always as predicted due to the following
problems:
Firstly, the relationship of bond price and yield is not linear
according to duration model but rather convex (has a curve) and the
duration model is the tangent line to that curve. Therefore, the
value changes depend on the degree of curvature and the larger the

curvature the larger the change. The convexity of bond is affected

by various factors such as maturity, coupon rate. The convexity
increases with maturity thus in this case asset has higher convexity
comparing to liability and according to the graph below, the higher
the convexity (bond A) will always change more positively that is
when interest decreases, their value will increase more and when
interest increases, the value will decrease less thus asset would
always change more positively than liability and thus equity
increase would be higher in this case.

Secondly, duration model is a dynamic problem that is duration

changes quickly overtimes as interest rate changes. Therefore, the
duration of asset and liability may already changed by the time the
change in cash rate is implemented thus leading different change of
equity comparing to the model. Therefore, banks needs to carefully
rebalance their balance sheet in order to achieve the desired hedge
which has large transaction costs.
Next, banks tend to cut back the cash rate passed on by the RBA
due to high competitions. More specifically, the bank tends to
decrease the cut or even increase cost of funding in order to attract
deposit and at call saving to have stable funding sources despite a
cut in cash rate. On the contrary, despite a cut in cash rate, the
bank may not decrease the lending rate in order to afford the high
funding cost. Therefore, interest rate change would not be the same
on the asset and liability sides for a given reduction in cash rate and
leading different equity value change. This can be illustrated from

the fact that the net margin of the bank has been decreasing since
2010 (from 2.47% to 2.13%) showing that funding cost increases
relatively to lending rate.
Lastly, run-off cash flow is also another factor that impact not only
duration gap but also repricing gap. Run-off cash flow is the problem
that the payments are not always as planned such as repaid of
deposit or withdrawal of fund before maturity. Similar to this is the
rescheduling of payment or default on the counter party which
would lead to increase or decrease of duration.