2. Leverage and returns The following tables show the balance sheets of two banks: Big Bank and Small Bank. Big Bank Balance Sheet Assets Liabilities and Net Worth Reserves $100,000 Checking deposits Loans outstanding $400,000 Stockholders' equity Total $500,000 Total Small Bank Balance Sheet Assets Liabilities and Net Worth Reserves $0 Checking deposits $0 Loans outstanding Stockholders' equity $100,000 $100,000 $100,000 Total Total $100,000 is a levered bank, while Small Bank is an unlevered bank. Big Bank $450,000 $50,000 $500,000 Big Bank is a levered bank, while Small Bank is an unlevered bank. Assume that both banks offer an annual rate of 3% on checking deposits and charge an annual rate of 5% on loans. and the annual return on loans is S For Big Bank, the annual interest cost on deposits is $ Bank earns a net profit of $ which represents a rate of return of % (Hint: Round to 1 decimal place.) on stockholders' equity. For Small Bank, the annual interest cost on deposits is $ Hence, Small Bank ears a net profit of $ which represents a rate of return of % (Hint Round to 1 decimal place.) on stockholders' equity Suppose that the value of loans in both banks declines by 10%. The amount of loans outstanding for Big Bank decreases from $400,000 to $ which represents a loss of % (Hint: Round to 1 decimal place) of stockholders' equity. The amount of loans outstanding for Small Bank decreases from $100,000 to $ which represents a loss of % (Hint Round to 1 decimal place.) stockholders' equity exposes its investors to greater risk in Therefore, Big Bank provides a higher rate of return to its investors, and Big Bank the event of a decline in the value of Joans. and the annual return on loans is $ Hence, Big