A financial institution has the following market value balance sheet structure: Assets Liabilities and Equity Cash Bond $ 1,000 Certificate of deposit 10,000 Equity $10,000 1,000 Total assets $ 11,000 Total liabilities and equity $11,000

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 1-year maturity and a 6 percent fixed rate of interest. The FI expects no additional asset growth. What will be the net interest income 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 this result caused by reinvestment risk or refinancing risk?

c. Assuming that market interest rates increase 1 percent, the bond will have a value of $9,446 at the end of year1.

What will be the market value of equity for the FI? Assume that all of the NII in part

(a) is used to cover operating expenses or 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 $1,000? Why?

e. What factors have caused the changes in operating performance and mar- ket value for this firm?