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1. Consider a bank that issues $200 million of liabilities with two years to maturity to finance the purchase of $200 million of assets with

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1. Consider a bank that issues $200 million of liabilities with two years to maturity to finance the purchase of $200 million of assets with a one year maturity. Suppose that the cost of funds (liabilities) for the bank is 5 percent per year and the return on the assets is 9 percent per year. a. Calculate the bank's profit spread and dollar value of profit in year 1 . b. Calculate the profit spread and dollar value of profit in year 2 , if the bank can reinvest its assets at 9 percent. c. If interest rates fall and the bank can invest in one-year assets at 6 percent in the second year, calculate the bank's profit spread and dollar value of profit in year 2. d. If interest rates rise and the bank can invest in one-year assets at 11 percent in the second year, calculate the bank's profit spread and dollar value of profit in year 2. e. Is the bank facing refinancing or reinvestment risk? Why? 2. Consider the simple bank balance sheet below (in millions of dollars). Suppose that depositors unexpectedly withdraw $50 million in deposits and the bank receives no new deposits to replace them. Assume that the bank cannot borrow any more funds in the shortterm money markets, and because it cannot wait to get better prices for its assets in the future (as it needs the cash now to meet immediate depositor withdrawals), the bank has to sell any nonliquid assets at 75 cents on the dollar. Show the bank's balance sheet after adjustments are made for the $50 million of deposit withdrawals

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