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Chapter 08 - Interest Rate Risk I

Solutions for End-of-Chapter Questions and Problems: Chapter Eight

1. How do monetary policy actions made by the Federal Reserve impact interest rates?

Through its daily open market operations, such as buying and selling Treasury bonds and
Treasury bills, the Fed seeks to influence the money supply, inflation, and the level of interest
rates. When the Fed finds it necessary to slow down the economy, it tightens monetary policy by
raising interest rates. The normal result is a decrease in business and household spending
(especially that financed by credit or borrowing). Conversely, if business and household
spending decline to the extent that the Fed finds it necessary to stimulate the economy it allows
interest rates to fall (an expansionary monetary policy). The drop in rates promotes borrowing
and spending.

2. How has the increased level of financial market integration affected interest rates?

Increased financial market integration, or globalization, increases the speed with which interest
rate changes and volatility are transmitted among countries. The result of this quickening of
global economic adjustment is to increase the difficulty and uncertainty faced by the Federal
Reserve as it attempts to manage economic activity within the U.S. Further, because FIs have
become increasingly more global in their activities, any change in interest rate levels or volatility
caused by Federal Reserve actions more quickly creates additional interest rate risk issues for
these companies.

3. What is the repricing gap? In using this model to evaluate interest rate risk, what is meant
by rate sensitivity? On what financial performance variable does the repricing model
focus? Explain.

The repricing gap is a measure of the difference between the dollar value of assets that will
reprice and the dollar value of liabilities that will reprice within a specific time period, where
repricing can be the result of a roll over of an asset or liability (e.g., a loan is paid off at or prior
to maturity and the funds are used to issue a new loan at current market rates) or because the
asset or liability is a variable rate instrument (e.g., a variable rate mortgage whose interest rate is
reset every quarter based on movements in a prime rate). Rate sensitivity represents the time
interval where repricing can occur. The model focuses on the potential changes in the net interest
income variable. In effect, if interest rates change, interest income and interest expense will
change as the various assets and liabilities are repriced, that is, receive new interest rates.

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Chapter 08 - Interest Rate Risk I

4. What is a maturity bucket in the repricing model? Why is the length of time selected for
repricing assets and liabilities important when using the repricing model?

The maturity bucket is the time window over which the dollar amounts of assets and liabilities
are measured. The length of the repricing period determines which of the securities in a portfolio
are rate-sensitive. The longer the repricing period, the more securities either mature or will be
repriced, and, therefore, the more the interest rate risk exposure. An excessively short repricing
period omits consideration of the interest rate risk exposure of assets and liabilities are that
repriced in the period immediately following the end of the repricing period. That is, it
understates the rate sensitivity of the balance sheet. An excessively long repricing period
includes many securities that are repriced at different times within the repricing period, thereby
overstating the rate sensitivity of the balance sheet.

5. What is the CGAP effect? According to the CGAP effect, what is the relation between
changes in interest rates and changes in net interest income when CGAP is positive? When
CGAP is negative?

The CGAP effect describes the relation between changes in interest rates and changes in net
interest income. According to the CGAP effect, when CGAP is positive the change in NII is
positively related to the change in interest rates. Thus, an FI would want its CGAP to be positive
when interest rates are expected to rise. According to the CGAP effect, when CGAP is negative
the change in NII is negatively related to the change in interest rates. Thus, an FI would want its
CGAP to be negative when interest rates are expected to fall.

6. Which of the following is an appropriate change to make on a bank’s balance sheet

when GAP is negative, spread is expected to remain unchanged and interest rates are
expected to rise?

According to the CGAP effect, when GAP, or CGAP, is positive the change in NII is positively
related to the change in interest rates. Thus, an FI would want its GAP to be positive when
interest rates are expected to rise.

a. Replace fixed-rate loans with rate-sensitive loans

Yes. This change will increase RSAs, which will increase GAP.

b. Replace marketable securities with fixed-rate loans

No. This change will decrease RSAs, which will decrease GAP.

c. Replace fixed-rate CDs with rate-sensitive CDs

No. This change will increase RSLs, which will decrease GAP.

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Chapter 08 - Interest Rate Risk I

d. Replace equity with demand deposits

No. This change will have no impact on either RSAs or RSLs. So, will have no impact on GAP.

e. Replace vault cash with marketable securities

Yes. This change will increase RSAs, which will increase GAP.

7. If a bank manager was quite certain that interest rates were going to rise within the next six
months, how should the bank manager adjust the bank’s six-month repricing gap to take
advantage of this anticipated rise? What if the manger believed rates would fall in the next
six months.

When interest rates are expected to rise, a bank should set its repricing gap to a positive position.
In this case, as rates rise, interest income will rise by more than interest expense. The result is an
increase in net interest income. When interest rates are expected to fall, a bank should set its
repricing gap to a negative position. In this case, as rates fall, interest income will fall by less
than interest expense. The result is an increase in net interest income.

8. Consider the following balance sheet positions for a financial institution:

• Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million

• Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million

• Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million

a. Calculate the repricing gap and the impact on net interest income of a 1 percent
increase in interest rates for each position.

• Rate-sensitive assets = $200 million. Rate-sensitive liabilities = $100 million.

Repricing gap = RSA - RSL = $200 - $100 million = +$100 million.

NII = ($100 million)(0.01) = +$1.0 million, or $1,000,000.

• Rate-sensitive assets = $100 million. Rate-sensitive liabilities = $150 million.

Repricing gap = RSA - RSL = $100 - $150 million = -$50 million.

NII = (-$50 million)(0.01) = -$0.5 million, or -$500,000.

• Rate-sensitive assets = $150 million. Rate-sensitive liabilities = $140 million.

Repricing gap = RSA - RSL = $150 - $140 million = +$10 million.

NII = ($10 million)(0.01) = +$0.1 million, or $100,000.

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Chapter 08 - Interest Rate Risk I

b. Calculate the impact on net interest income on each of the above situations assuming a
1 percent decrease in interest rates.

• NII = ($100 million)(-0.01) = -$1.0 million, or -$1,000,000.

• NII = (-$50 million)(-0.01) = +$0.5 million, or $500,000.

• NII = ($10 million)(-0.01) = -$0.1 million, or -$100,000.

c. What conclusion can you draw about the repricing model from these results?

The FIs in parts (1) and (3) are exposed to interest rate declines (positive repricing gap), while
the FI in part (2) is exposed to interest rate increases. The FI in part (3) has the lowest interest
rate risk exposure since the absolute value of the repricing gap is the lowest, while the opposite is
true for the FI in part (1).

9. Consider the following balance sheet for MMC Bancorp (in millions of dollars):

Assets Liabilities
1. Cash and due from $ 6.25 1. Equity capital (fixed) $25.00
2. Short-term consumer loans 62.50
(one-year maturity) 2. Demand deposits 50.00
3. Long-term consumer loans 31.25
(two-year maturity) 3. Passbook savings 37.50
4. Three-month T-bills 37.50 4. Three-month CDs 50.00
5. Six-month T-notes 43.75 5. Three-month banker’s
acceptances 25.00
6. Three-year T-bonds 75.00 6. Six-month commercial paper 75.00
7. 10-year, fixed-rate mortgages 25.00 7. One-year time deposits 25.00
8. 30-year, floating-rate
mortgages 50.00 8. Two-year time deposits 50.00
9. Premises 6.25
$337.50 $337.50

a. Calculate the value of MMC’s rate-sensitive assets, rate sensitive liabilities, and
repricing gap over the next year.

Looking down the asset side of the balance sheet, we see the following one-year rate-sensitive
assets (RSA):

1. Short-term consumer loans: $62.50 million, which are repriced at the end of the year and just
make the one-year cutoff.
2. Three-month T-bills: $37.50 million, which are repriced on maturity (rollover) every three
months.

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Chapter 08 - Interest Rate Risk I

3. Six-month T-notes: $43.75 million, which are repriced on maturity (rollover) every six
months.
4. 30-year floating-rate mortgages: $50.00 million, which are repriced (i.e., the mortgage rate is
reset) every nine months. Thus, these long-term assets are RSA in the context of the repricing
model with a one-year repricing horizon.

Summing these four items produces one-year RSA of $193.75 million. The remaining $143.75
million is not rate sensitive over the one-year repricing horizon. A change in the level of interest
rates will not affect the interest revenue generated by these assets over the next year. The $6.25
million in the cash and due from category and the $6.25 million in premises are nonearning
assets. Although the $131.25 million in long-term consumer loans, three-year Treasury bonds,
and 10-year, fixed-rate mortgages generate interest revenue, the level of revenue generated will
not change over the next year since the interest rates on these assets are not expected to change
(i.e., they are fixed over the next year).

Looking down the liability side of the balance sheet, we see that the following liability items
clearly fit the one-year rate or repricing sensitivity test:

1. Three-month CDs: $50 million, which mature in three months and are repriced on rollover.
2. Three-month bankers acceptances: $25 million, which mature in three months and are
repriced on rollover.
3. Six-month commercial paper: $75 million, which mature and are repriced every six months.
4. One-year time deposits: $25 million, which are repriced at the end of the one-year gap
horizon.

Summing these four items produces one-year rate-sensitive liabilities (RSL) of $175 million. The
remaining $162.50 million is not rate sensitive over the one-year period. The $25 million in
equity capital and $50 million in demand deposits do not pay interest and are therefore classified
as nonpaying. The $37.50 million in passbook savings and $50 million in two-year time deposits
generate interest expense over the next year, but the level of the interest generated will not
change if the general level of interest rates change. Thus, we classify these items as fixed-rate
liabilities.

The four repriced liabilities ($50 + $25 + $75 + $25) sum to $175 million, and the four repriced
assets of $62.50 + $37.50 + $43.75 + $50 sum to $193.75 million. Given this, the cumulative
one-year repricing gap (CGAP) for the bank is:

CGAP = (One-year RSA) - (One-year RSL) = RSA - RSL = $193.75 million - $175 million =
$18.75 million

b. Calculate the expected change in the net interest income for the bank if interest rates
rise by 1 percent on both RSAs and RSLs. If interest rates fall by 1 percent on both
RSAs and RSLs.

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Chapter 08 - Interest Rate Risk I

The CGAP would project the expected annual change in net interest income ()NII) of the bank is:
)NII = CGAP x )R
= ($18.75 million) x 0.01
= $187,500

Similarly, if interest rates fall equally for RSAs and RSLs, NII will fall by:
= ($18.75 million) x (-0.01)
= -$187,5000

c. Calculate the expected change in the net interest income for the bank if interest rates
rise by 1.2 percent on RSAs and by 1 percent on RSLs. If interest rates fall by 1.2
percent on RSAs and by 1 percent on RSLs.

The resulting change in NII is calculated as:

)NII = [RSA x )RRSA] - [RSL x )RRSL]
= [$193.75 million x 1.2%] - [$175 million x 1.0%]
= $2.325 million - $1.75 million
= $575,000

10. What are the reasons for not including demand deposits as rate-sensitive liabilities in the
repricing analysis for a commercial bank? What is the subtle but potentially strong reason
for including demand deposits in the total of rate sensitive liabilities? Can the same
argument be made for passbook savings accounts?

The regulatory rate available on demand deposit accounts is zero. Although many banks are able
to offer NOW accounts on which interest can be paid, this interest rate seldom is changed and
thus the accounts are not really interest rate sensitive. However, demand deposit accounts do pay
implicit interest in the form of not charging fully for checking and other services. Further, when
market interest rates rise, customers draw down their demand deposit accounts, which may cause
the bank to use higher cost sources of funds. The same or similar arguments can be made for
passbook savings accounts.

11. What is the gap to total assets ratio? What is the value of this ratio to interest rate risk
managers and regulators?

The gap to total assets ratio is the ratio of the cumulative gap position to the total assets of the FI.
The cumulative gap position is the sum of the individual gaps over several time buckets. The
value of this ratio is that it tells the direction of the interest rate exposure and the scale of that
exposure relative to the size of the FI.

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Chapter 08 - Interest Rate Risk I

12. Which of the following assets or liabilities fit the one-year rate or repricing sensitivity test?

3-month U.S. Treasury bills Yes

1-year U.S. Treasury notes Yes
20-year U.S. Treasury bonds No
20-year floating-rate corporate bonds with annual repricing Yes
30-year floating-rate mortgages with repricing every two years No
30-year floating-rate mortgages with repricing every six months Yes
Overnight fed funds Yes
9-month fixed-rate CDs Yes
1-year fixed-rate CDs Yes
5-year floating-rate CDs with annual repricing Yes
Common stock No

13. What is the spread effect?

The spread effect is the effect that a change in the spread between rates on RSAs and RSLs has
on net interest income as interest rates change. The spread effect is such that, regardless of the
direction of the change in interest rates, a positive relation exists between changes in the spread
and changes in NII. Whenever the spread increases (decreases), NII increases (decreases).

14. A bank manager is quite certain that interest rates are going to fall within the next six
months. How should the bank manager adjust the bank’s six-month repricing gap and
spread to take advantage of this anticipated rise? What if the manger believes rates will rise
in the next six months.

When interest rates are expected to fall, a bank should set its repricing gap to a negative position.
Further, the manager would want to increase the spread between the return on RSAs and RSLs.
In this case, as rates fall, interest income will fall by less than interest expense. The result is an
increase in net interest income. When interest rates are expected to rise, a bank should set its
repricing gap to a positive position. Again, the manager would want to increase the spread
between the return on RSAs and RSLs. In this case, as rates rise, interest income will rise by
more than interest expense. The result is an increase in net interest income.

15. Consider the following balance sheet for WatchoverU Savings, Inc. (in millions):

Assets Liabilities and Equity

Floating-rate mortgages 1-year time deposits
(currently 10% annually) $50 (currently 6% annually) $70
30-year fixed-rate loans 3-year time deposits
(currently 7% annually) $50 (currently 7% annually) $20
Equity $10
Total assets $100 Total liabilities & equity $100

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Chapter 08 - Interest Rate Risk I

a. What is WatchoverU’s expected net interest income at year-end?

Current expected interest income: $50m(0.10) + $50m(0.07) = $8.5m.

Expected interest expense: $70m(0.06) + $20m(0.07) = $5.6m.
Expected net interest income: $8.5m - $5.6m = $2.9m.

b. What will net interest income be at year-end if interest rates rise by 2 percent?

After the 2 percent interest rate increase, net interest income declines to:
50(0.12) + 50(0.07) - 70(0.08) - 20(.07) = $9.5m - $7.0m = $2.5m, a decline of $0.4m.

c. Using the cumulative repricing gap model, what is the expected net interest income for
a 2 percent increase in interest rates?

WatchoverU’s repricing or funding gap is $50m - $70m = -$20m. The change in net interest
income using the funding gap model is (-$20m)(0.02) = -$0.4m.

d. What will net interest income be at year-end if interest rates on RSAs increase by 2
percent but interest rates on RSLs increase by 1 percent? Is it reasonable for changes in
interest rates on RSAs and RSLs to differ? Why?

After the unequal rate increases, net interest income will be 50(0.12) +
50(0.07) - 70(0.07) - 20(.07) = $9.5m - $6.3m = $3.2m, an increase of $0.3m. It is not
uncommon for interest rates to adjust in an unequal manner on RSAs versus RSLs. Interest rates
often do not adjust solely because of market pressures. In many cases, the changes are affected
by decisions of management. Thus, you can see the difference between this answer and the
answer for part a.

16. Use the following information about a hypothetical government security dealer named M.
P. Jorgan. Market yields are in parenthesis, and amounts are in millions.

Assets Liabilities and Equity

Cash $10 Overnight repos $170
1-month T-bills (7.05%) 75 Subordinated debt
3-month T-bills (7.25%) 75 7-year fixed rate (8.55%) 150
2-year T-notes (7.50%) 50
8-year T-notes (8.96%) 100
5-year munis (floating rate)
(8.20% reset every 6 months) 25 Equity 15
Total assets $335 Total liabilities & equity $335

a. What is the repricing gap if the planning period is 30 days? 3 months? 2 years? Recall
that cash is a non-interest-earning asset.

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Chapter 08 - Interest Rate Risk I

Repricing gap using a 30-day planning period = $75 - $170 = -$95 million.
Repricing gap using a 3-month planning period = ($75 + $75) - $170 = -$20 million.
Reprising gap using a 2-year planning period = ($75 + $75 + $50 + $25) - $170 = +$55 million.

b. What is the impact over the next 30 days on net interest income if interest rates increase
50 basis points? Decrease 75 basis points?

If interest rates increase 50 basis points, net interest income will decrease by $475,000.
NII = CGAP(R) = -$95m.(0.005) = -$0.475m.

If interest rates decrease by 75 basis points, net interest income will increase by $712,500. NII
= CGAP(R) = -$95m.(-0.0075) = $0.7125m.

c. The following one-year runoffs are expected: $10 million for two-year T-notes and $20
million for eight-year T-notes. What is the one-year repricing gap?

The repricing gap over the 1-year planning period = ($75m. + $75m. + $10m. + $20m. +
$25m.) - $170m. = +$35 million.

d. If runoffs are considered, what is the effect on net interest income at year-end if interest
rates increase 50 basis points? Decrease 75 basis points?

If interest rates increase 50 basis points, net interest income will increase by $175,000. NII =
CGAP(R) = $35m.(0.005) = $0.175m.

If interest rates decrease 75 basis points, net interest income will decrease by $262,500. NII =
CGAP(R) = $35m.(-0.0075) = -$0.2625m.

17. A bank has the following balance sheet:

Assets Avg. Rate Liabilities/Equity Avg. Rate

Rate sensitive $550,000 7.75% Rate sensitive $375,000 6.25%
Fixed rate 755,000 8.75 Fixed rate 805,000 7.50
Nonearning 265,000 Nonpaying 390,000
Total $1,570,000 Total $1,570,000

Suppose interest rates rise such that the average yield on rate-sensitive assets increases by
45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis
points.

a. Calculate the bank’s repricing GAP, gap to total assets ratio, and gap ratio.

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Chapter 08 - Interest Rate Risk I

Repricing GAP = $550,000 - $375,000 = $175,000

Gap to total assets ratio = $175,000/$1,570,000 = 11.15%
Gap ratio = $550,000/$375,000 = 1.467%

b. Assuming the bank does not change the composition of its balance sheet, calculate the
resulting change in the bank’s interest income, interest expense, and net interest income.

II = $550,000(0.0045) = $2,475

IE = $375,000(0.0035) = $1,312.50
NII = $2,475 - $1,312.50 = $1,162.50

c. Explain how the CGAP and spread effects influenced the change in net interest income.

The CGAP affect worked to increase net interest income. That is, the CGAP was positive while
interest rates increased. Thus, interest income increased by more than interest expense. The result
is an increase in NII. The spread effect also worked to increase net interest income. The spread
increased by 10 basis points. According to the spread affect, as spread increases, so does net
interest income.

18. A bank has the following balance sheet:

Assets Avg. Rate Liabilities/Equity Avg. Rate

Rate sensitive $550,000 7.75% Rate sensitive $575,000 6.25%
Fixed rate 755,000 8.75 Fixed rate 605,000 7.50
Nonearning 265,000 Nonpaying 390,000
Total $1,570,000 Total $1,570,000

Suppose interest rates fall such that the average yield on rate-sensitive assets decreases by
15 basis points and the average yield on rate-sensitive liabilities decreases by 5 basis
points.

a. Calculate the bank’s CGAP, gap to total asset ratio, and gap ratio.

CGAP = $550,000 - $575,000 = -$25,000

Gap to total assets ratio = -$25,000/$1,570,000 = -1.59%
Gap ratio = $550,000/$575,000 = 0.957

b. Assuming the bank does not change the composition of its balance sheet, calculate the
resulting change in the bank’s interest income, interest expense, and net interest income.

II = $550,000(-0.0015) = -$825

IE = $575,000(-0.0005) = -$287.50
NII = -$825 – (-$287.50) = -$537.50

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Chapter 08 - Interest Rate Risk I

c. The bank’s CGAP is negative and interest rates decreased, yet net interest income
decreased. Explain how the CGAP and spread effects influenced this decrease in net
interest income.

The CGAP affect worked to increase net interest income. That is, the CGAP was negative while
interest rates decreased. Thus, interest income decreased by less than interest expense. The result
is an increase in NII. The spread effect, on the other hand, worked to decrease net interest
income. The spread decreased by 10 basis points. According to the spread affect, as spread
decreases, so does net interest income. In this case, the increase in NII due to the CGAP effect
was dominated by the decrease in NII due to the spread effect.

19. The balance sheet of A. G. Fredwards, a government security dealer, is listed below.
Market yields are in parentheses, and amounts are in millions.

Assets Liabilities and Equity

Cash $20 Overnight repos $340
1-month T-bills (7.05%) 150 Subordinated debt
3-month T-bills (7.25%) 150 7-year fixed rate (8.55%) 300
2-year T-notes (7.50%) 100
8-year T-notes (8.96%) 200
5-year munis (floating rate)
(8.20% reset every 6 months) 50 Equity 30
Total assets $670 Total liabilities and equity $670

a. What is the repricing gap if the planning period is 30 days? 3 month days? 2 years?

Repricing gap using a 30-day planning period = $150 - $340 = -$190 million.
Repricing gap using a 3-month planning period = ($150 + $150) - $340 = -$40 million.
Repricing gap using a 2-year planning period = ($150 + $150 + $100 + $50) - $340 = $110 million.

b. What is the impact over the next three months on net interest income if interest rates on
RSAs increase 50 basis points and on RSLs increase 60 basis points?

II = ($150m. + $150m.)(0.005) = $1.5m.

IE = $340m.(0.006) = $2.04m.
NII = $1.5m. – ($2.04m.) = -$0.54m.

c. What is the impact over the next two years on net interest income if interest rates on
RSAs increase 50 basis points and on RSLs increase 75 basis points?

II = ($150m. + $150m. + $100 + $50)(0.005) = $2.25m.

IE = $340m.(0.0075) = $2.04m.
NII = $2.25m. – ($2.04m.) = $0.21m.

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Chapter 08 - Interest Rate Risk I

d. Explain the difference in your answers to parts (b) and (c). Why is one answer a
negative change in NII, while the other is positive?

For the 3-month analysis, the CGAP affect worked to decrease net interest income. That is, the
CGAP was negative while interest rates increased. Thus, interest income increased by less than
interest expense. The result is a decrease in NII. For the 3-year analysis, the CGAP affect worked
to increase net interest income. That is, the CGAP was positive while interest rates increased.
Thus, interest income increased by more than interest expense. The result is an increase in NII.

20. A bank has the following balance sheet:

Assets Avg. Rate Liabilities/Equity Avg. Rate

Rate sensitive $225,000 6.35% Rate sensitive $300,000 4.25%
Fixed rate 550,000 7.55 Fixed rate 505,000 6.15
Nonearning 120,000 Nonpaying 90,000
Total $895,000 Total $895,000

Suppose interest rates rise such that the average yield on rate-sensitive assets increases by
45 basis points and the average yield on rate-sensitive liabilities increases by 35 basis
points.

a. Calculate the bank’s repricing GAP.

Repricing GAP = $225,000 - $300,000 = -$75,000

b. Assuming the bank does not change the composition of its balance sheet, calculate the
net interest income for the bank before and after the interest rate changes. What is the
resulting change in net interest income?

NIIb = ($225,000(0.0635) +$550,000(0.0755)) – ($300,000(0.0425) + $505,000(0.0615))

= $55,812.50 - $43,807.50 = $12,005

NIIa = ($225,000(0.0635 + 0.0045) +$550,000(0.0755)) – ($300,000(0.0425 + 0.0035) +

$505,000(0.0615)) = $56,825 - $44,857.50 = $11,967.50

NII = $11,967.50 - $12,005 = -$37.50

c. Explain how the CGAP and spread effects influenced this increase in net interest
income.

8-12
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Chapter 08 - Interest Rate Risk I

The CGAP affect worked to decrease net interest income. That is, the CGAP was negative while
interest rates increased. Thus, interest income increased by less than interest expense. The result
is a decrease in NII. In contrast, the spread effect worked to increase net interest income. The
spread increased by 10 basis points. According to the spread affect, as spread increases, so does
net interest income. However, in this case, the increase in NII due to the spread effect was
dominated by the decrease in NII due to the CGAP effect.

21. What are some of the weakness of the repricing model? How have large banks solved the
problem of choosing the optimal time period for repricing? What is runoff cash flow, and
how does this amount affect the repricing model’s analysis?

The repricing model has four general weaknesses:

(1) It ignores market value effects.

(2) It does not take into account the fact that the dollar value of rate-sensitive assets and
liabilities within a bucket are not similar. Thus, if assets, on average, are repriced earlier in
the bucket than liabilities, and if interest rates fall, FIs are subject to reinvestment risks.

(3) It ignores the problem of runoffs. That is, that some assets are prepaid and some liabilities
are withdrawn before the maturity date.

(4) It ignores income generated from off-balance-sheet activities.

Large banks are able to reprice securities every day using their own internal models so
reinvestment and repricing risks can be estimated for each day of the year.

Runoff cash flow reflects the assets that are repaid before maturity and the liabilities that are
withdrawn unexpectedly. To the extent that either of these amounts is significantly greater than
expected, the estimated interest rate sensitivity of the FI will be in error.

The following questions and problems are based on material in Appendix 8A, located on the
website (www.mhhe.com/saunders8e).

22. What is a maturity gap? How can the maturity model be used to immunize an FI’s
portfolio? What is the critical requirement that allows maturity matching to have some
success in immunizing the balance sheet of an FI?

Maturity gap is the difference between the average maturity of assets and liabilities. If the
maturity gap is zero, it is possible to immunize the portfolio so that changes in interest rates will
result in equal but offsetting changes in the value of assets and liabilities. Thus, if interest rates
increase (decrease), the fall (rise) in the value of the assets will be offset by an identical fall (rise)
in the value of the liabilities. The critical assumption is that the timing of the cash flows on the
assets and liabilities must be the same.

8-13
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Chapter 08 - Interest Rate Risk I

23. Nearby Bank has the following balance sheet (in millions):

Assets Liabilities and Equity

Cash $60 Demand deposits $140
5-year Treasury notes 60 1-year certificates of deposit 160
30-year mortgages 200 Equity 20
Total assets $320 Total liabilities and equity $320

What is the maturity gap for Nearby Bank? Is Nearby Bank more exposed to an increase or
decrease in interest rates? Explain why?

MA = [0x$60 + 5x$60 + 30x$200]/$320 = 19.6875 years, and ML = [0x$140 + 1x$160]/$300 =

0.5333 years. Therefore, the maturity gap = MGAP = 19.6875 – 0.5333 = 19.1542 years. Nearby
Bank is exposed to an increase in interest rates. If rates rise, the value of assets will decrease by
more than the value of liabilities.

24. County Bank has the following market value balance sheet (in millions, all interest at
annual rates). All securities are selling at par equal to book value.

Assets Liabilities and Equity

Cash $20 Demand deposits $100
15-year commercial loan at 10% 5-year CDs at 6% interest,
interest, balloon payment 160 balloon payment 210
30-year mortgages at 8% interest, 20-year debentures at 7% interest, 120
balloon payment 300 balloon payment
Equity 50
Total assets $480 Total liabilities & equity $480

a. What is the maturity gap for County Bank?

MA = [0x$20 + 15x$160 + 30x$300]/$480 = 23.75 years.

ML = [0x$100 + 5x$210 + 20x$120]/$430 = 8.02 years.
MGAP = 23.75 – 8.02 = 15.73 years.

b. What will be the maturity gap if the interest rates on all assets and liabilities increase by
1 percent?

If interest rates increase one percent, the value and average maturity of the assets will be:
Cash = $20
Commercial loans = $16xPVAn=15, i=11% + $160xPVn=15,i=11% = $148.49
Mortgages = $24xPVAn=30,i=9% + $300xPVn=30,i=9% = $269.18
MA = [0x$20 + 15x$148.49 + 30x$269.18]/($20 + $148.49 + $269.18) = 23.54 years

8-14
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Chapter 08 - Interest Rate Risk I

The value and average maturity of the liabilities will be:

Demand deposits = $100
CDs = $12.60xPVAn=5,i=7% + $210xPVn=5,i=7% = $201.39
Debentures = $8.4xPVAn=20,i=8% + $120xPVn=20,i=8% = $108.22
ML = [0x$100 + 5x$201.39 + 20x$108.22]/($100 + $201.39 + $108.22) = 7.74 years

The maturity gap = MGAP = 23.54 – 7.74 = 15.80 years. The maturity gap increased because the
average maturity of the liabilities decreased more than the average maturity of the assets. This
result occurred primarily because of the differences in the cash flow streams for the mortgages
and the debentures.

c. What will happen to the market value of the equity?

The market value of the assets has decreased from $480 to $437.67, or $42.33. The market value
of the liabilities has decreased from $430 to $409.61, or $20.39. Therefore, the market value of
the equity will decrease by $42.33 - $20.39 = $21.94, or 43.88 percent.

25. If a bank manager is certain that interest rates were going to increase within the next six
months, how should the bank manager adjust the bank’s maturity gap to take advantage of
this anticipated increase? What if the manager believes rates will fall? Would your
suggested adjustments be difficult or easy to achieve?

When rates rise, the value of the longer-lived assets will fall by more the shorter-lived liabilities.
If the maturity gap is positive, the bank manager will want to shorten the maturity gap or make it
negative. If the maturity gap is negative, the manager might do nothing. If rates are expected to
decrease, the manager should reverse these strategies. Changing the maturity on the balance
sheet often involves changing the mix of assets and liabilities. Attempts to make these changes
may involve changes in financial strategy for the bank which may not be easy to accomplish.
Later in the text, methods of achieving the same results using derivatives will be explored.

26. An insurance company has invested in the following fixed-income securities: (a)
$10,000,000 of five-year Treasury notes paying 5 percent interest and selling at par value,
(b) $5,800,000 of 10-year bonds paying 7 percent interest with a par value of $6,000,000,
and (c) $6,200,000 of 20-year subordinated debentures paying 9 percent interest with a par
value of $6,000,000.

a. What is the weighted-average maturity of this portfolio of assets?

MA = [5x$10m + 10x$5.8m + 20x$6.2m]/$22m = 232/22 = 10.55 years

b. If interest rates change so that the yields on all of the securities decrease 1 percent, how
does the weighted-average maturity of the portfolio change?

8-15
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Other documents randomly have
different content
that this ever-present magic of genius, the unequalled command of
beautiful fresh phrases, the hurrying rush of exquisite ideas, first
shines out most conspicuously: the youth of passion in the Romeo,
and the soul of romance, are accompanied by the gay wit of glorious
Mercutio and the lax humours of the Nurse and the servants.
Shakespeare was compelled to kill Mercutio by Tybalt's sword,
otherwise a character so congenial to him would have run away with
the play, and turned the tragedy into comedy. Shakespeare, says
Ben Jonson, "had an excellent phantasy" (fancy), "brave notions and
gentle expressions, wherein he flowed with such facility that
sometimes it was necessary he should be stopped." Mercutio could
only be stopped by a sword thrust! The "Midsummer Night's Dream"
is the enchanted consummation of the world-wide fairy belief,
relieved against the rustic comedy of Bottom and Snug.
"The Two Gentlemen of Verona," like "Love's Labour's Lost," is a bud
full of promise. Launce is as delightfully humorous as Silvia is gay
and charming, and Julia is the first of the ladies in page's guise and
deep in love; but "Romeo and Juliet," and "A Midsummer Night's
Dream" are already nonpareils, full-blown roses that time cannot
wither.
The "Comedy of Errors," based on Plautus, with the farcical errors of
indistinguishable identities in the masters, reduplicated in the
servants, would add by its broad farce to Shakespeare's popularity,
though not to his fame. But in "The Merchant of Venice" the
blending of moral tragedy in the sombre character of the outraged
Jew, Shylock, combined with the delightful and tender romance of
the lovers, proved the multifarious versatility of the poet, his power
in the delineation of the most various moods and passions, and also
the unequalled magic of his verse.
On such a night
Stood Dido with a willow in her hand
Upon the wild sea-banks, and waft her love
To come again to Carthage.
Here Virgil is equalled or surpassed in the province where Virgil was
greatest; in the use of words that by some inexplicable art suggest
more than they seem to say, filling the mind with vague and potent
emotion, and a longing not to be appeased, as does the beauty of
twilight and moonlight.
Look how the floor of heaven
Is thick inlaid with patines of bright gold;
There's not the smallest orb which thou beholdest
But in his motion like an angel sings,
Still quiring to the young-eyed cherubims;
Such harmony is in immortal souls;
But, whilst this muddy vesture of decay
Doth grossly close it in, we cannot hear it.
In this passage, whether he knew it or not—and we know not how
he knew things,—Shakespeare soars to the heights of Plato's
dreams, in the "Phædrus" and the "Symposium". Did he go beyond
the appreciation of "the groundlings" in such passages? Did they find
mirth in the passion of the Jew, and fail to fathom Shakespeare's
deep sympathy with the oppressed? Probably he gave them more
and other things than he seemed to give; to them Shylock's may
have appeared as a comic part, but indeed we cannot judge that
strange Elizabethan audience. Shakespeare knew what they wanted,
horrors, ghosts, revenges, manslayings. He gave them these things
in "Lear" and "Hamlet," but gave with them the deepest and subtlest
thoughts, the most magical poetry, treasures of wit, and all this they
could enjoy, as they could follow every point, pass, and parry in the
wit-combats.
It seems probable that Shakespeare's fame as a poet rested, for a
while, rather on his verses, "Venus and Adonis" (published 1593)
and "Lucrece" (1594), than on all the treasures of his plays. The two
poems, the only works of Shakespeare's which he himself saw
through the press, are dedicated, in brief terms, to Henry
Wriothesley, Earl of Southampton, then a lad of twenty, fond of
pleasure, art, and letters. The dedications are not fulsome, when we
consider the manner of addressing patrons in that age. The second
address, of some ten lines, says "the love I dedicate to your lordship
is without end.... What I have done is yours; what I have to do is
yours; being part in all I have, devoted yours." It seems that
Southampton had behaved with generosity to the poet, and it looks
as if the poet's "love" were more than the trick-phrase of a person
obliged.
The poems themselves, "Venus and Adonis" in a six line stanza,
"Lucrece" in a seven line stanza, are remarkable for fluent mastery
of verse and rhyme, for lusciousness of description of physical
beauties, and for the compassionate passage on the poor hunted
hare, and the vigorous description of a horse. Shakespeare
manifestly loved a good horse, and probably felt compunctions about
riding to harriers. But as to the poetry; it certainly is not superior to
the luscious descriptions in Spenser; the verse is by no means
superior to, nor, to some tastes, equal to Spenser's; and, if we lost
Marlowe's "Hero and Leander," the misfortune would be as great as
if we lost "Venus" and "Lucrece". The two compositions show us
Shakespeare exercising himself on a fashionable class of themes,
and with an overflow of fashionable conceits; sufflaminandus erat,
says Ben Jonson; "the drag needed to be put on". Had we nothing
else of Shakespeare's, we could make no guess at his greatness.
Indeed his contemporaries could hardly do so, till his plays were
pirated and printed, because all their innumerable merits could not
be fully appreciated till the plays were meditatively and frequently
perused. By 1598, Francis Meres, comparing English with ancient
poets, names Shakespeare and others with Homer, Æschylus,
Sophocles and Aristophanes, also Ausonius and Claudian. But he
places Warner in the same good company (in "Palladis Tamia," or
"Wit's Treasury," 1598).
The plays named by Meres are "Two Gentlemen of Verona,"
"Comedy of Errors," "Love's Labours Lost," "Love's Labour's Won"
(?), "Midsummer Night's Dream," "Merchant of Venice," both
"Richards," "Henry IV," "King John," "Titus Andronicus," and "Romeo
and Juliet". "The soul of Ovid lives in mellifluous and honey-tongued
Shakespeare, witness his 'Venus and Adonis,' his 'Lucrece,' his
sugared sonnets, among his private friends." (Not published till
1609.)
Gullio, in the Cambridge comedy, "The Return from Parnassus"
(about 1599-1602) is a farcical ignorant braggart who says "let this
duncified world esteem of Spenser and Chaucer, I'll worship sweet
Mr. Shakespeare," for his "Venus and Adonis". He also quotes
"Romeo and Juliet," and the University wits manifestly despised
Shakespeare, as no scholar and not a University man. They bade
Ben Jonson go back to his brick-making; he was not a University
man!
Meanwhile Shakespeare, with his share in the company and what he
received for his written plays, and from patrons, was thriving, while
his father struggled with debt and difficulties. None the less,
probably aided pecuniarily and advised by Shakespeare, he applied
to the College of Arms for a grant of armorial bearings (1596). A
memorandum exists in which John Shakespeare is said to have
"lands and tenements of good wealth and substance". The grant was
not made till 1599, and the heralds appear to have been very good-
natured in permitting these Shakespeares to write themselves
gentlemen. The financial basis, however, was supplied when, in
1597, Shakespeare bought New Place, a large house in the town of
Stratford, and two gardens. Sir Sidney Lee reckons his income,
allowing for the altered values of money, at £1040 in our currency.
In short, like Scott, Shakespeare lived to found a family of gentility,
though Scott naturally inherited the gentility and heraldic
quarterings, which Shakespeare did not. He prospered continually;
he held, later, shares in the Globe theatre, and there is abundant
proof that in money, acres, and goods he throve to an extent that
denotes careful living. He appears as a strict exactor of debts: in
nothing was he careless and indifferent except as regarded the
immortal works, which, after his death, his 'stage friends, Heming
and Condell, published as best they might (1623, the first folio).
Shakespeare seems, in fact, to have had even more than Scott's
indifference to his literary fame, unless we suppose him to have
been firmly persuaded that his works, once given to the stage, must
secure their own immortality. Even so, he might have employed the
leisure of his last years in preparing a correct text for the press.
Yet who knows that Shakespeare did not dream of doing what was
unprecedented, of revising and collecting his plays for publication?
Playwrights seldom printed their dramas, for reasons already given.
But, in 1616, the year of Shakespeare's death, Ben Jonson published
his "works" (he was laughed at for calling them "works") in a tall and
stately folio. It may have been in Shakespeare's mind to do the
same thing: but "to-morrow and to-morrow and to-morrow"! He may
have contemplated the difficult task, he may even have made fair
copies of some of his manuscripts of his many unprinted plays,—the
papers which his friends, the actors, say had "scarce a blot". But his
older manuscripts may have been tattered and worn, and altered for
better or worse. To collect and revise all was a serious labour for a
retired, perhaps a weary man. He was but 52 when he died; he may,
we repeat, have dreamed of a task which he put off from day to
day: there is no mystery in delays so natural when the custom of
play writers was not to publish.

The Sonnets.
It is difficult or impossible to date Shakespeare's Sonnets. As we
know from Meres, "sugared sonnets" of his were circulating in
manuscript in 1598: the book of Sonnets was (piratically?) published
in 1609 with a dark dedication to "Mr. W. H.," by the pirate, or
procurer of piracy, Thorpe, "To the only begetter of these sonnets
Mr. W. H. all happiness and that eternity promised by our ever-living
poet wisheth the well-wishing adventurer in setting forth T.T.". T.T.
did not wish to be understood. The two most popular theories are
that Mr. W. H. is William Herbert, in 1601 Earl of Pembroke; before
his accession to the Earldom, he was known by "courtesy title" as
Lord Herbert. To him then, about 1598-1601, the Sonnets to a man
are addressed.
The second theory lays stress on Shakespeare's known devotion to
the Earl of Southampton; certainly his patron, and assured of his
love in the dedications of "Venus" and "Lucrece," in 1593, 1594. The
Sonnets are therefore dated about 1594, whereas, by the Pembroke
theory, they are dated about 1598-1601.
It is not possible, in this place, to criticize the two theories. The
matter is of no importance in itself, but some partisans of the
Pembroke theory represent Shakespeare as embittered almost to
madness by the affair, constantly alluded to in the Sonnets, of a
double betrayal by his mistress, the Dark Lady, and by his adored
friend the Earl of Pembroke. Henceforth we are to suppose, he
revealed his passions in his tragedies, and was a fevered creature,
dreaming of "bloody vengeance".
There is not a shadow of proof for the hypothesis that the Dark Lady
of the Sonnets was a Maid of Honour, Mary Fitton, whose portraits
demonstrate that she was of a fair complexion, with grey eyes and
brown hair. We have not the slightest reason to believe that, in
1597-1601, when he was building up an estate, Shakespeare was
mad with love of Mary, and jealousy of her lovers who, after 1601,
are unknown, till, in 1606, she committed a fault, in the country. Of
the two Earls, Southampton, rather more probably than Pembroke,
was, if either of them was, the beloved friend of the Sonnets.[7]
The Sonnets are not in the Italian or Petrarchian form of recurring
rhymes, but are in three verses of four lines, with a rhyming couplet
to conclude. In many respects they resemble the sonnets
fashionable at the time, with praise of a patron whom the poet loves
and who is the inspiration of the poet. The accustomed conceits of
Petrarch and his French followers, des Portes, Ronsard, and many
others, are transfigured by the poet's genius. It was usual to
applaud the beauty of the patron, and to exaggerate the love of the
poet.
This was matter of common form, but the sonnets of Shakespeare
reflect the actual passion of love, or of friendship "passing the love
of women," yet always respectful. People wrote thus to Elizabeth in
her old age, but Shakespeare conveys an impression of sincerity,
whether because he felt what he expresses, or whether his genius
makes real and glowing that which was, with other writers, mere
matter of compliment. He may be "unlocking his heart," in either
case, for he must have known, for some one, the passion which, on
the second theory, he dramatically employs to glorify his young
inspirer. Yet again, he could imitate and express "all thoughts, all
passions": his "sweetest nature" can scarcely have known the
emotions of Shylock!
However we may try to distinguish between what is conventional
and what is felt in the Sonnets, they apparently refer to real persons
and real situations. Sonnets I-XVII urge marriage on the beautiful
young patron and friend: his beauties and virtues must live in his
children as well as in verse. Sonnets XXXIII-XXXVI hint at some
measure of estrangement, some wrong done to the poet by the
friend.
No more be grieved at that which thou hast done.
Sonnets XL-XLIII suggest that the friend has drawn away the poet's
mistress.
I do forgive thy robbery, gentle thief,
Although thou steal thee all my poverty.
Such are
The pretty wrongs that liberty commits.
The suffering poet appears to bear no malice, it must be admitted.
Thenceforward there are regrets for the absence of the friend,
beautiful reflections, promises of immortality in verse, till (LXVII) the
poet hears that the friend keeps bad company, and though (LXX)
this may be an envious slander, the poet has his doubts. In LXVIII-
XCIII the poet feels that the patron is preferring other minstrels, and
one of these he applauds for
 the proud full sail of his great verse.
This singer is inspired by
that affable familiar ghost
Which nightly gulls him with intelligence.[8]
Here are personal allusions to some facts, or jests, which we cannot
hope to discover: the rival poet has been guessed at as Barnabe
Barnes ("Parthenope and Parthenophil," 1593), who certainly wrote
a sonnet on the inspiration of Southampton's eyes. Others think that
George Chapman, the translator of Homer, is the rival whom
Shakespeare writes of admiringly. In XCV-XCVI the poet recurs to the
stories which "spot the beauty of thy budding name". In CIV he has
loved his friend for three years,
Three April perfumes in three hot Junes burned.
Yet he goes on in the old strain of love and praise, though
What's new to speak, what new to register?
In CX-CXI he perhaps laments his own profession as a player;
perhaps he refers to changes in his affections. Taking the whole of
this and the preceding sonnet together, the second seems the more
natural interpretation. In Sonnet CXI, Fortune is blamed
That did not better for my life provide
Than public means which public manners breeds,
Thence comes it that my name receives a brand.
The name of actor was, indeed, branded as no better than that of
vagabond, while the play-writers constantly called the players
"apes," and "mimics". Here Shakespeare does seem to speak of his
profession:—
I have gone here and there
And made myself a motley to the view.
With CXXVII begin Sonnets addressed to a woman, a dark lady, but
(CXXX) not very beautiful.
 My mistress' eyes are nothing like the sun.
This may be a mere criticism of the absurd hyperboles of admiration
by contemporary sonneteers. In CXXXIII the poet seems to upbraid
the lady for taking his friend from him, and through three sonnets
this plaint is poured out with obscure puns on "will" and "Will," his
name, and—some think—his friend's name. The poet is (CXLIV)
placed between "two spirits that suggest me still", One good, is a
man; one evil, a woman.
To win me soon to hell, my female evil
Tempteth my better angel from my side,
And would corrupt my saint to be a devil.
In addressing the woman, the poet is much more outspoken than
when addressing the man on
The pretty wrongs that liberty commits.
The poet, like Catullus with Lesbia, loves against his reason and his
knowledge of the woman's true nature (CXLVII),
Past cure am I, now reason is past care,
And frantic-mad with evermore unrest;
My thoughts and my discourse as madman's are,
At random from the truth vainly expressed;
For I have sworn thee fair, and thought thee bright,
Who art as black as hell, as dark as night.
If all this be in earnest, we have a tragedy of the heart, whether in
1594, or in 1598-1601, or in neither. Again and again, in his plays,
Shakespeare mocks at sonnets and sonneteers; and though his, in
parts, are personal, the depth of their significance, and the
persistence of his emotions, must be left to the literary instinct of
the reader. We cannot reconstruct Shakespeare's self out of his
works, lyrical or dramatic. Had the sonnets been recognized as
reflecting a scandalous episode in society, it could scarcely have
followed that "no sequence of such poems was received more
coldly". Those of Sidney, Daniel, Drayton, and Constable, were often
reprinted. Shakespeare's had not even a second edition till 1640.[9]
It is unfortunate that literary history can scarcely pass by, leaving
these strange guesses about a strange matter unnoticed. The
sonnets in themselves are a book of golden verse, shining with gems
of beautiful phrases,
The stretched metre of an antique song.

Shall I compare thee to a summer's day?

Thou art more lovely and more temperate.

The painful warrior famoused for fight,

After a thousand victories once foiled.
Full many a glorious morning have I seen
Flatter the mountain-tops with sovereign eye.

When in the chronicle of wasted time

I see descriptions of the fairest wights
And beauty making beautiful old rhyme
In praise of ladies dead and lovely knights.

Not mine own fears, nor the prophetic soul

Of the wide world dreaming on things to come.
This beautiful poem (CVII) most manifestly refers to Shakespeare's
forebodings about "my true love," who was "supposed as forfeit to a
confined doom" (Southampton, in 1601, was sentenced to captivity
for life). But "The mortal moon hath her eclipse endured," that is
Elizabeth, Cynthia, is dead, "Luna's extinct," as contemporary
versifiers said. "In this most balmy time," Peace "proclaims olives of
endless age," that is the accession of James VI and I put an end to
fears of wars of a disputed succession. On 10 April, 1603, James
released Southampton.[10] The Sonnets, like "the floor of heaven,"
are "thick inlaid with patines of bright gold,".never to be dimmed by
mists of conjecture, or nonsense about Shakespeare as a sensual
sycophantic snob, mad with jealousy and foiled desire.

Later Plays.
Returning to the plays, we find, between 1597 and 1601,
Shakespeare in his second period, with "Henry IV," "The Merry Wives
of Windsor," "Henry V," "Much Ado about Nothing," "As You Like It,"
"Twelfth Night," and "Julius Cæsar". Such was the astonishing
harvest of five years. Probably "Henry IV" is the play which we
would retain, could we keep but one, so delightful is Falstaff, the fat
knight, the embodiment of the richest humour. He "has given us
medicines to make us love him," and even the delightful characters
of Hotspur, the Mercutio of the history, and of Lady Percy, take a far
lower place. We would banish all, and keep honest Jack. Many
cannot bear to see Falstaff have much the worse of the jest, as in
"The Merry Wives of Windsor," said to have been composed in a
fortnight, at the desire of Elizabeth, who wished to see that
impossibility, Falstaff in love. The characters of Shallow, Slender, Sir
Hugh, even the transient Anne Page, and all the broad humours of
life in an English country town, do not console us for the defeat of
the hero.
It is in "Henry V" that Shakespeare not only emphasizes his love of
England, nobly expressed by John of Gaunt in "Richard II," but
makes it the mainspring of the drama. The yeomen soldiers in the
play frankly tell the disguised king that they doubt the justice of his
cause—and well they may, for no man ever had a worse, and
Shakespeare must have known it,—but "our country, right or
wrong," must be the motto of the playwright, and he puts into
Henry's mouth the speeches that still stir the blood like the sound of
a trumpet. Much has been written on Henry's hardness to Falstaff,
whose heart he broke,—but Henry at least acts in accordance with
his actual character, a brave, able, ruthless, and hard man, always
convinced of his own righteousness. Pistol's braggart humour is as
good as ever, and that learned man of the sword, Fluellen, is a
forerunner of Scott's Dugald Dalgetty.
"Much Ado about Nothing," "As You Like It," and "Twelfth Night"
(1599-1600) are the three central stars in the crown of
Shakespeare's comic Muse. More humorous than "Henry IV" they
cannot be, but in them is no admixture of history, and the women in
the three are ladies, whereas in "Henry IV" Lady Percy is the chief
contrast with Falstaff's Mrs. Quickly, and her crew. Shakespeare
cannot, we may suppose, have lived in the intimate society of the
ladies of Elizabeth's Court; he must have divined and created
Beatrice ("a star danced, and under that was she born") and Hero,
sweetly bearing the accusations of her intolerable lover, Claudio:—
I have marked
A thousand blushing apparitions
To start into her face, a thousand shames
In angel whiteness beat away these blushes,
And in her eye there hath appeared a fire
To burn the errors that these princes hold
Against her maiden truth.
The mirth and high spirit of Beatrice, the humours of Benedick,
endear the comedy to every reader, yet the end is "huddled up," like
the ends of many of the plays; Claudio is lightly taken back into
favour, with Shakespeare's almost limitless tolerance. He can
scarcely ever bring himself to punish one of his rogues, such as
Lucio and Parolles, and is as clement to the less deserving Claudio.
The mirth of "Twelfth Night" might border on the farcical, if Sir Toby,
Maria, Sir Andrew Aguecheek, and the rest of the light people, were
not so delightfully human and living, like their butt, Malvolio; and did
not Viola and Olivia lend their exquisite grace. Meanwhile, in "As You
Like It," we fleet our time carelessly as they did in the golden world,
under the greenwood tree, in the enchanted company of Rosalind,
Touchstone, the greatest of Shakespeare's clowns, and the
melancholy and humorous Jaques, the contemplator.
Returning to historical drama, and using North's translation of
Plutarch as his material, fusing North's prose into blank verse, he
now produced "Julius Cæsar," in which the chief personages are
Brutus, Marcus Antonius, and the Roman populace. Brutus appears
as the virtuous and irresolute man, slave to a pedantic conscience
which pushes him on to the slaying of great Cæsar. All readers note
Shakespeare's way of placing a man of nature more or less noble,
but irresolute, in a crisis which demands decision. Hamlet, Brutus,
and Macbeth are the great examples. It does not follow that
Shakespeare himself was irresolute, and that, when he thought of a
man who is obliged to take a constant part, he felt that, had he been
that man, he would have wavered. He simply, chose to illustrate that
tragedy of a soul. Where would be the interest in a play of Hamlet
had the prince gone straight to his mark and slain the king "at
sight"? There would have been no play! How could we endure a
Brutus who, in his relations with Cæsar, mobbed and stabbed the
greatest of mortals, in a forthright business manner, with no
hesitations? If there were not enough of nobility in Macbeth to
unman him, he would be a vulgar usurper. When he chose,
Shakespeare could design men as true to their single aim as Richard
III and Iago. Tragedy requires in the chief sufferer, as the Greeks
saw, greatness with a fatal blemish; this idea runs through their
poetry from Achilles to the Aias and Œdipus of Sophocles. The
purpose of Brutus, a deed, to reverse his own words, "to make
whole men sick," when in contemplation, would not let him eat, nor
talk, nor sleep; but, once resolved, his heart is steeled, nor does the
ghost of Cæsar fright him, as the spectres of his fancy appal
Macbeth.
The other great character is the fickle Roman crowd, played on by
the rhetoric of Antony. Shakespeare was not hostile to the people,
but the mob he knew, and drew it relentlessly again and again.
"Hamlet" (1602) is believed to have been based on a lost drama of
1589, perhaps by Kyd; the original source is the "History of the
Danes" by Saxo Grammaticus, and there was a French version by
Belleforest. Of Shakespeare's play there are three versions, a
hopelessly imperfect text in a pirated quarto of 1603; abetter,
"enlarged to almost as much again" (1604); and the Folio edition of
1623. None of these is good, as a text; and the inconsistencies of
the play may in part be due to an admixture of the old piece, and to
tamperings with the manuscript.
Of "Hamlet" it is vain to speak briefly, and more than enough of
speaking at large has been done by a myriad of commentators. The
young prince, full of good qualities, is bound with knots which a real
Dane of the Saga time would have cut with the short sword. But
Hamlet has "the prophetic soul of the wide world, dreaming" of life,
and death, and love, and contrary duties. Thus he, like Œdipus in
the Greek tragedy, becomes as fatal to all around him as if he bore
the Evil Eye; and while, like David at Ziklag, he is playing the
madman, actual madness hangs over him like the sword of
Damocles. Thus Shakespeare has left to the world a marvel of subtle
and penetrative thought, of tenderness, of humour; to the critics a
wrangle over psychological problems.
The same unparalleled powers, the same universality, the same
gloomy vision of life, and, in "King Lear," another study of true and
of feigned madness, inspire "Lear," "Macbeth," and "Othello," the
last the most piteous of all. For in Othello it is not the error of a
wavering hero, or the ambition of a man tempted, like Macbeth, by
portents and prophecies, but the sheer inborn devilry of a creature
in human form, Iago, that "breaks, and brings down death" on the
most innocent of victims, Desdemona. "The pity of it" is too awful:
the sense of wyrd, of masterful destiny, is too cruel.
Yet, if Shakespeare were to write tragedies, and to write them on
the traditional materials which are the bases of these plays, it was
inevitable that, as he wrote, he should have regarded life as he
does, and human fortunes as the spoil of wayward and cruel fate.
Æschylus could not make pretty melancholy pieces out of the
materials of the "Agamemnon" and "Eumenides". He, to be sure,
tried to justify the ways of the gods to men, and Shakespeare makes
no such effort. His characters, in the immortal words of Nicias to his
doomed Athenian army, "have done what men may, and endure
what men must". "The rest is silence."
Of Troilus and Cressida (1603), printed 1609, we can only say that
Shakespeare when he wrote it "was for one hour less noble than
himself". The piece makes mockery—save for Odysseus,—of the
heroes of Homer, and of Cressida, whom Chaucer treats with such
fine chivalry. Thersites is merely loathsome, Aias a fool, Achilles a
treacherous procurer of the death of Hector. Shakespeare made an
impossible blend of Homer (of whom he clearly knew a little),[11] of
Ovid, and of the mediaeval forms of the Tale of Troy. The elements
are wholly incompatible, and the mood of the poet, whether he
wrote the play early or late, was unenviable.
"Unpleasantness" is also the not undeserved charge against
"Measure for Measure"; but Cinthio's Italian tale, on which it is
founded, was "a sordid record of lust and cruelty". Shakespeare,
altering the plot, redeemed it by the figure of Isabella, and by the
sad Mariana in her "moated grange".
It cannot be denied that when Shakespeare added "Timon of
Athens," the tragedy of a misanthrope, to "Troilus," and then
produced the extremely unpleasant scenes in "Pericles" (which is not
in the Folio of 1623, the first edition of his collected plays) he was
selecting topics that encourage the belief in his own bitterness of
spirit, while in "Antony and Cleopatra" the magnificent study of "the
serpent of old Nile," and of the ruin she wrought, he continues his
vein of thought on the accidents that bring courage and greatness to
the dust.
In "Coriolanus" he contrasts the fickleness of the mob with an heroic
soul ruined by its relentless exaggeration of its own merits and
overweening greatness; the tragedy of Napoleon is a modern
instance. Dating the play in 1608-1609, critics derive the character
of the mother of Coriolanus from Shakespeare's thoughts of his own
mother, who died in 1608. Of her character, of course, we know
absolutely nothing.
The "tranquillity" of "Cymbeline" so rich in poetry, and so recklessly
constructed; of the "Winter's Tale," where the poetry is yet more
divine, and the plot is as heaven pleases; and of "The Tempest"
(1613), where much of the "local colour" is derived from the
adventures of English sea-men in the Bermudas (1609-1610), is
explained by the resignation of increasing years.
We cannot reason thus with much confidence. Shakespeare could
only have produced "The Tempest" in the plenitude of his genius,
but he might have created it as it stands at any date after 1596,
when he happened to take up the materials.
"Henry VIII" was being played in 1613 when the Globe Theatre was
burned. That parts are by Shakespeare, parts by Fletcher, is a theory
resting on the elusive internal evidence of style and quality.
From 1611 till his death in 1616, Shakespeare is thought to have
lived mainly at home, at Stratford, where his daughters married men
in their own situation of life. Shakespeare died on April 23, 1616. By
1623 his monument in Stratford Church had been erected.
Ben Jonson wrote, "I loved the man and do honour his memory, on
this side idolatry, as much as any. He was indeed honest, and of an
open and free nature."
Shakespeare, in accordance with Greek and Roman wisdom, had
chosen the fallentis semita vitæ; in his private course he was
studiously obscure. His all-embracing and unparalleled genius was
exhibited only in his art, and in his profession by which he lived and
prospered. He had carried blank verse from the point at which
Marlowe left it to a never equalled pitch of various perfection; while
his lyrics are worthy of "all the angels singing out of heaven". His
creations of character are in number, variety, and excellence,
unrivalled; he touched with the surest hand every chord in the
human heart; he explored every height and depth, and despite the
inevitable stains left by his age, and the haste necessitated by his
profession, his work attains the high-water mark of human genius.
Jonson.
Ben Jonson (born 1572-73) is believed to have been descended from
the Annandale border clan of the Johnstones. His father, after
suffering troubles under Mary Tudor, became a Protestant preacher.
Ben was a posthumous child, his mothers second husband was a
bricklayer or builder. The boy was educated at Westminster school,
under Camden, the antiquarian and historian, to whom he more
than once expressed his gratitude. His name as an undergraduate is
not found in the records of either Oxford or Cambridge. Jonson did
not long practise his stepfather's useful art: he served through a
campaign in Flanders, and told Drummond of Hawthornden that he
slew, in single combat, a champion of the enemy. He had more than
a literary acquaintance with the fencing terms which his Captain
Bobadil uses with so much gusto. Returning to England he fell
among actors and playwrights, is mentioned as a tragedian by Meres
("Palladis Tamia") in 1598, was challenged by an actor, Gabriel
Spencer, whom he slew in fair fight; was imprisoned; turned
Catholic, not for long; and, on his release, married. By 1596 he had
worked with very minor playwrights at forgotten plays, and had
tinkered at "The Spanish Tragedy ". He now wrote "Every Man in His
Humour," an early form of the play, which he revised; removing the
scene from Florence to London, for its repetition in 1598, when
Shakespeare's company were the players. In the Prologue he
ridiculed, as Sidney had done, the reckless early dramas, in which
the hero lives a long life on the stage, while "three rusty swords"
furnish forth a stage army, and squibs and stage thunder delight the
audience. He aims at good-humoured comedy of everyday life,
laughs at "such errors as you'll all confess," and in Master Stephen
draws a shadowy Shallow, a predecessor of Bob Acres, while that
stock-figure, the poltroon bragging copper-Captain Bobadil, survives
in loving memory as an excellent study in a familiar "character-part,"
the "Miles Gloriosus," of the Roman comedian.
The personages are citizens of the day, the anxious father; the
downright squire; a "Town Gull," or dupe, Master Matthew, to match
the country gull, the melancholy and gentlemanlike Master Stephen;
while Kitely illustrates the humours of jealousy. The characters are
types, each with his "humour," or ruling passion of foible, and the
standing butt is Hieronymo in Kyd's "Spanish Tragedy". As the author
parodies forgotten plays, and makes use of forgotten catch-words, it
may justly be said that "much of his humour still remains in
obscurity". In Shakespearean humour, with its sweet tolerance,
enduring quality, and sympathy and gentle melancholy, Ben is totally
deficient. His "humours" are idiosyncrasies or "fads" or "ruling
passions" carried into ludicrous extremes.
The success of "Every Man in His Humour" prompted "Every Man out
of His Humour," acted in 1599, by Shakespeare's company, and
printed, "Containing more than hath been publicly spoken or acted,"
in 1600. Jonson was as eager to print his plays as Shakespeare was
indifferent. The comedy was much too long, and had been "cut"
severely by the players. It has a kind of chorus of spectators and
critics, and is an exhibition of "humours" (the word was then a piece
of popular slang), or types. Sogliardo is an amusing bourgeois
gentilhomme, who, like Shakespeare, "lacks" what he calls a
"cullisen" (scutcheon) and will stick at no expense to purchase one.
The romantic and euphuistic humours of Puntarvolo and his lady are
excellent fooling; Macilente, the bitterly envious, suggests, in a more
tragic style, his contemporary, Scott's Sir Mungo Malagrowther (in
"The Fortunes of Nigel"); the coxcomb, Fastidious Brisk, is an
agreeable rattle, especially in his account of his duel and his dresses,
boots, hat, and jewellery; and the compliment by Macilente to the
Queen is charmingly courtly, coming from that blustering mountain
of a man, the author. But the play was not a success. For this, or for
any other reason (perhaps because they cut down his plays into
manageable size), Ben quarrelled with the actors, Shakespeare's
company, and began to write satirical plays on the players, and on
the poets who were more successful than himself, or who had
theories that were not his about how plays should be written, about
"art," in his favourite phrase. In different moods he spoke differently
about Shakespeare's "art," now saying that he had none; now that
without art and labour Shakespeare could not have produced his
"true-filed" phrases.
"Cynthia's Revels" (1600) was acted by "the children of the Royal
Chapel," and printed in 1601. (New scenes were added in the Folio
edition of 1616). A lively prologue is acted by the boys, who quarrel
for the privilege of speaking it. One of them mimics a coxcomb
spectator, with three sorts of tobacco to smoke on the stage. Among
the humours of the Court, Crites is taken to represent the author
himself, "this Crites is sour". The exquisite song (ex forti dulcedo)
"Queen and huntress, chaste and fair," outlives the humours, and
the satire, which was personal, for the gentlemen of the press and
stage, then, as now, liked personal controversy, "it is such easy
writing".
The "Poetaster"(1601) runs amuck against actors. "They forget that
they are in the statute" (against vagabonds) "the rascals; they are
blazoned there... they and their pedigrees; they need no other
heralds, I wis." This was an anachronism, at the Court of Augustus,
the scene of the play, but appropriate to Shakespeare's new
scutcheon. The loves of Ovid and Julia, Virgil reading the "Æneid" to
Augustus, are mixed with contemporary satire to which Dekker
replied in "Satiro-Mastix, or the untrussing of the Humorous Poet"
(acted by Shakespeare's company, 1602).
Marston (Crispinus) was also assailed, and war raged on the lower
slopes of the Muses' hill. Since the beginnings of the theatre, play-
writers have parodied and mocked each others' works, as
Aristophanes caricatured Euripides, as ancient Pistol parodied
Marlowe's "jades of Asia," and Molière made mirth of the tragedies
played by the company of the Hôtel de Bourgogne. But Ben, though
a huge, noisy, and truculent adversary, was placable, and he and
Marston became friends. Much ingenuity has been spent in detecting
hits at Shakespeare in Ben's plays and epigrams; very probably
some of his cutting allusions are aimed at his successful rival, but it
needs two to make a quarrel.
When James VI of Scotland came to the English throne, and lived no
longer on the allowance of £3000 a year from Elizabeth, he spent
very largely on elaborate masques, courtly entertainments, not
unlike the ballets in which Louis XIV later danced his parts. The
hosts of Greek mythology were let loose on the stage, all the sea-
nymphs, daughters of Oceanus, for example, floating in a shell of
mother-of-pearl, among Tritons better schooled in their parts than
honest Mike Lambourn in "Kenilworth". The dresses scenery, and
decorations, "the bodily parts, were of Master Inigo Jones his design
and act" (see "The Masque of Blackness," 1605). The Queen and the
Court ladies acted, or at least appeared as sea-nymphs, and Ben
produced the words, which were deeply learned, and the exquisite
songs. Unrefined as he was, he became intimate with hospitable and
generous lords and ladies. Their gifts and his payment from the
Royal coffers in pensions were of more profit to him than his plays,
for which he said that he received only £200. It is hardly necessary
to add that he had bitter quarrels with Inigo Jones.
Jonson's Roman tragedy, "Sejanus" (1603) on the fortunes and fall
of that favourite of the Emperor Tiberius, is deeply learned. The
author, in the printed version, gave references in footnotes, to his
authorities, Tacitus, Juvenal, Suetonius, and many others, as if he
had been writing a severe work of history. Nothing can be less like
Shakespeare's Roman tragedies, with his free handling of North's
translation of Plutarch, with his wild mobs, and murder done openly.
Ben was classical and accurate; his Romans speak a stately blank
verse: his Tiberius, slow, formal, hypocritical, and deceitful above all
things, is the Tiberius of Tacitus; his all-daring Sejanus is a less
candid Richard III; and though Ben admitted that the ancient
Chorus, with its chants, was impossible on the English stage, he
was, in other respects, conscientiously classical. The whole heavy air
of Rome, the terror, the duplicity, the political influence of women,
their passion, the servility and the discontent, live in the somewhat
ponderous blank verse, of which Ben first wrote the matter in prose,
an uninspired method.
The "Catiline and His Conspiracy," acted 1611, "did not please the
populace," nor the Court much, as Ben admits in a quotation from
Horace: in these "jig-given times" he asked Pembroke's patronage
for "a legitimate poem". In fact Jonson with all his amazing energy,
vigour, and appreciation of character—that of Cicero is excellent—
was too pedantic, and the orations of his Cicero were too long for
the stage. The odes of the Chorus were not apt to increase the
pleasure of the audience.
Ben's recognized comic masterpieces were "The Fox (Volpone)" first
acted at the Universities, then at the Globe, 1605; "The Silent
Woman" (1609), "The Alchemist" (1610), and "Bartholomew Fair"
(1614). Both in "The Fox" and "The Alchemist," there is something
that reminds us of Marlowe. The Fox, Volpone, a Venetian magnifico,
a childless man, for years pretends to be dying, surrounded by his
little court of obscene depravities, and aided by his parasite, Mosca,
gulls men who, each in his degree, is an incarnation of cruel greed.
Volpone is a voluptuary in his devilish delight in human corruption.
The aged Corbaccio he tempts to disinherit his son; the madly
jealous Corbino he tempts to prostitute his wife, from the avaricious
Volt ore and from all of them he wrings rich presents. It is a masque
of the Deadly Sins, and behind them stands Murder, hesitating
between poison, the dagger, and the smothering pillow, for all the
fortune-hunters would slay their tormentor if they dared.
The scene with the English Lady Would-be, an affected literary lady,
who tires Volpone to death with literary chatter, is more than the rest
in the true spirit of comedy. Celia, the suffering wife of Corbino, and
Bonario, the young son of the evil dotard, Corbaccio, alone represent
the soul of good in things evil. The plot is ingeniously entangled and
untied, and justice can scarcely add to the torments which the
characters owe to their own insatiate greed.
In "The Alchemist," three scoundrels, occupying by connivance of a
servant an empty house, and captained by Subtle, an alchemist, play
on the greed and lust of many "coneys". These each, in Jonson's
way, represent a "humour". Sir Epicure Mammon, the City Knight, is
all for unlimited lust, secured by the Elixir of Life and the
Philosopher's Stone. He is as eager as Faustus for the unlimited, and
as learned in his gloating discourses as Jonson himself, who, in
Subtle, displays all his knowledge of the jargon of alchemy. Dol
Common, the decoy, the Fairy Queen, has an extensive and peculiar
knowledge of Billingsgate; Abel Drugger, the tobacconist, hopes to
prosper in his trade by magical spells; the gamester, Pertinax Surly,
strong in his own marked cards and loaded dice, has a salutary
scepticism; and the two puritans, Ananias and Tribulation
Wholesome, are ready for anything which will supply finance for
their godly crew of Anarchists at Amsterdam. Ben well understood
these extreme fanatics, "a sect of dangerous consequence that will
have no king, but a presbytery," said Queen Elizabeth. They were
soon to put an end to "merry England," and, when we look at the
quality of much of the mirth in the later Jacobean plays, we are not
enamoured of either party in the conflict. The play, with its constant
bustle was and long remained popular. So did "Bartholomew Fair," a
colossal exhibition of a London festival, with all the humours of the
joyous populace, interrupted by Rabbi Busy, the fanatic, who has
eaten more roast pig than any one, and rushes about denouncing all
the other "Dagons" and "idols," like a bloated English Tartuffe, le
pauvre homme. The stocks do not daunt him, his tongue remains as
free as Mause Headrigg's. In an introduction to this enormous
burlesque Jonson throws scoffs at "The Tempest" of Shakespeare.
"The Silent Woman" is truly a roaring farce on a singular subject,
Morose, a gentleman as impatient of noise, and as certain that all
silence except his own was golden, as the Sage of Chelsea. How he
is saddled with a wife who, from being "mim as a mouse" becomes
the most vociferous of Roaring Boys, and, indeed to the confusion of
some boastful gallants, is a boy pranked up for the practical jokes
whereby Morose's nephew extracts Morose's money, may be read,
with much other mirthful noisy matter, by the curious.
"The Devil is an Ass" (1616) is a satire on conjurers, crystal-gazers,
projectors, or, as we say, "promoters" of bubble enterprises, and
their gulls and "coneys".
A walking tour to Scotland (1618-1619), where Jonson was
entertained by Drummond of Hawthornden, had for its fruit
Drummond's brief notes of his conversation and literary opinions. He
did not care much for Drummond's Petrarchian sonnets, "cross-
rhymes"; and, as to Shakespeare (whom Drummond himself does
not seem to have appreciated), merely said that "he wanted art,"
and that, in his geography, he was wrong when he gave Bohemia a
sea-coast. Happily Ben left splendid tributes other-where (in verses
attached to the first collected edition of Shakespeare's plays, "The
Folio" (1623), and in prose), to Shakespeare's genius and character.
Drummond's estimate of Ben as a braggart about himself, and a
contemner of others, as jealous and vindictive, is only true in part.
No man had more or more admiring friends; at taverns he reigned,
among the great wits "Sealed of the Tribe of Ben," like an earlier
Dryden.
His last plays "The New Inn," "The Magnetic Lady," and "The Tale of
a Tub," were badly received: in an Ode he
left the loathèd stage
And the more loathsome age;
he lost his place of Masque-maker in 1632, but was still befriended
by Charles I. He died on 6 August, 1637, before the troubles of the
Covenant came to a head.
His great collection of books and his treatise on the "Poetics" of
Aristotle and the "Art of Poetry" of Horace had already been
destroyed by a fire. Many of his beautiful lyrics exhibit that grace,
delicacy, and, in the best sense, poetry which are not conspicuous in
his plays. "His throne is not with the Olympians but with the Titans,"
and Tennyson could not endure the gloom which he found in
Jonson's comedies.
Scott, on the other hand, seems to have known them almost by
heart, and constantly quotes them, and, indeed, the whole host of
minor Elizabethan playwrights. The learning of Jonson, in Greek no
less than in Latin, is a marvel,
 Which is a wonder how his Grace should glean it,
in his prodigious activity of production. His immortal lyrics attest the
delicacy and grace which seldom inspire his plays, and, indeed, are
most noted in the lover; "a scholar and a gentleman," of his
incoherent play "The New Inn" (1629). Ben's drama is the work of a
"made" writer, the fruit of reflection on what the stage ought to be,
and of ponderous industry and diligent observation. We feel that the
plays, despite their richness and vigour, their masculine energy, are
somewhat prolix, rather pedantic, and they do not hold the stage,
like those of Shakespeare, at whom Ben scratched so often, without
moving the master to reply in kind.

Jonson's Prose.
It is not easy to sympathize with the sweet enthusiasts who place
Ben Jonson's "Timber, or Discoveries made upon Men and Matter,"
above Bacon's Essays. These sayings, maxims, and very brief essays
were mainly written when Ben was old, and not yet wise enough to
be contented. He appears as a contemner of times present, when
the poet is no longer taken at his own estimate, which, in Jonson's
case, was rather high. Many of the "Discoveries" had, not
infrequently or of recent date, been discovered before. Thus of
Fortune, "That which happens to any man, may to every man. But it
is in his reason what he accounts it, and will make it." This has been
put more briefly and better: "Nothing is good or bad but thinking
makes it so". Nothing can be more trite than this of waste of time,
but the expression is admirable, "What a deal of cold business doth
a man" (and do most women) "mis-spend the better part of life in!
In scattering compliments, tendering visits, gathering and venting
news, following feasts and plays, making a little winter-love in a dark
corner." But Jonson was not profuse in venting compliments, and,
with his enormous reading, can hardly have spent much time in
paying calls. The sentences on the decay of taste are passed by
elderly men of letters in all ages on "railing and tinkling rhymers,
whose writings the vulgar more greedily read..." "Expectation of the
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