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mancial institution has the following market value balance sheet structure: Assets Cash Bond Total assets Liabilities and Equ
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Answer #1

Solution ;-

(1)

Interest Income ($10000*10%) = $1000

Interest Expense ($10000*6%) = $600

Net Interest Income (NII) = $400

(2)

Interest Income ($10000*10%) = $1000

Interest Expense ($10000*7%) = $700

Net Interest Income (NII) = $300

The decrease in net interest income is caused by the increase in financing cost without a corresponding increase in the earnings rate. Thus, the change in NII is caused by refinancing risk. The increase in market interest rates does not affect the interest income because the bond has a fixed-rate coupon for ten years. Note: this answer makes no assumption about reinvesting the first year’s interest income at the new higher rate.

(3)

Cash $1,000 Certificate of Deposit $10,000
Bond $9,446 Equity $446
Total Assets $10,446 TotalLiabilities $10,446

(4)

The market value of the equity would be higher ($1,600) because the value of the bond would be higher ($10,600) and the value of the CD would remain unchanged.

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