A financial institution has the following market value balance sheet structure: Assets Liabilities and Equity
Cash $1,800 Certificate of deposit 10, 200
Bond $10,200 Equity 1,200
Total assets $12,000 Total liabilities and equity 12,000
A. The bond has a 10-year maturity, a fixed-rate coupon of 10 percent paid at the end of each year, and a par value of $10,000. The certificate of deposit has a one-year maturity and a 6 percent 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?
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 $9.657 at the end of year 1. What will be the market value of the equity for the Fl? 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 $1.2002?
E. What factors have caused the changes in operating performance and market value for this FI?