Consider the following two banks:

Bank 1 has assets composed solely of a 10-year, 12 percent coupon, $1 million loan with a 12 percent yield to maturity. It is financed with a 10-year, 10 percent coupon,

$1 million CD with a 10 percent yield to maturity.

Bank 2 has assets composed solely of a 7-year, 12 percent, zero-coupon bond with a current value of

$894,006.20 and a maturity value of $1,976,362.88. It is financed with a 10-year, 8.275 percent coupon, $1,000,000 face value CD with a yield to maturity of 10 percent.

All securities except the zero-coupon bond pay interest annually. (LG 3-4)

a. If interest rates rise by 1 percent (100 basis points), how do the values of the assets and liabilities of each bank change?

b. What accounts for the differences between the two banks’ accounts?

AppendixLO1