Question

A financial institution has the following market value balance sheet structure: Assets Cash Bond Total assets Liabilities and Equity $ 1,900 Certificate of deposit 10.300 Equity $12,200 Total liabilities and equity $10,900 1,300 $12,200 a. The bond has a 10-year maturity, a fixed-rate coupon of 11 percent paid at the end of each year, and a par value of $10,300. The certificate of deposit has a 1-year maturity and a 5 percent fixed rate of interest. The Fl expects no additional asset growth. What will be the net interest income (NII) at the end of the first year? (Note: Net interest income equals interest income minus interest expense.) b. If at the end of year 1 market interest rates have increased 100 basis points (1 percent), what will be the net interest income for the second year? Is the change in NII caused by reinvestment risk or refinancing risk? C. Assuming that market interest rates increase 1 percent, the bond will have a value of $9,751 at the end of year 1. What will be the market value of the equity for the FI? Assume that all of the Nil in part (a) is used to cover operating expenses or is distributed as dividends. d. If market interest rates had decreased 100 basis points by the end of year 1, would the market value of equity be higher or lower than $1,300? e. What factors have caused the changes in operating performance and market value for this FI? Complete this question by entering your answers in the tabs below. Required A Required B Required C Required D Required E The bond has a 10-year maturity, a fixed-rate coupon of 11 percent paid at the end of each year, and a par value of $10,300 The certificate of deposit has a 1-year maturity and a 5 percent fixed rate of interest. The FI expects no additional asset growth. What will be the net interest income (NII) at the end of the first year? (Note: Net interest income equals interest income minus interest expense.) Net interest income (NII) Required >

Answer 1

Solution We now that net interest income = Interest Income - Interest Expense AMOUNT 1133 PARTICULARS Interest income = 10300 X 11% (Bond) Interest expense = 10900 X 5% (Certificate of deposit) Net interest income 545 588 As bond is on asset side, we shall earn interest at coupon rate of 11% As certificate of deposit is on liability side, we shall pay interest at given rate of 5%