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2 Liquidity Mismatch Consider a bank whose assets are composed of risky assets and Treasuries (both with 10-year durations) and whose liabilities are made up
2 Liquidity Mismatch Consider a bank whose assets are composed of risky assets and Treasuries (both with 10-year durations) and whose liabilities are made up of equity and debt. To begin with, suppose that on the asset side, the bank holds 80% risky assets and 20 Treasuries, while on the liabilities side, the bank has 90% short-term debt (deposits) and 10% equity. In the following questions, you will be asked how the bank's portfolio composition changes when it takes certain actions. Use these numbers as the reference portfolio for all questions 1. Suppose that the bank sells Treasuries and uses the proceeds to buy risky assets such that after the swap, its holdings are 95% risky assets and 5% Treasuries. Assume the bank issues no additional liabilities. (a) How does the bank's leverage change? b) How does the bank's maturity mismatch change? (c) How does the bank's liquidity mismatch change? 2. Now suppose that the bank issues additional deposits and uses the proceeds to buy Treasuries so that its portfolio is composed of 40% risky assets and 60% Treasuries (a) What is the composition of the bank's liabilities now? How does the bank's leverage change? (b) How does the bank's maturity mismatch change? Assume the bank's equity has a duration of 20 vears. (c) How does the bank's liquidity mismatch change
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