5. (a) Consider a bank that has issued a 1yr deposit paying 6% pa to finance a 2yr loan earning 7% pa. What is the basis spread for the first year? What is the basis spread if rates do not change come the start of year 2? What is the 2yr spread if rates paid on deposits in year 2 increased to 8% pa?

(b) Consider a bank that has issued a 2yr deposit paying 14% pa to finance a 1yr loan earning 16% pa. What is the basis spread for the first year? What is the spread if rates do not change come the start of year 2? What is the 2yr spread if rates earned on assets in year 2 falls to 12% pa?

(c). What type of risk did the bank face in (a) and (b)? What risk do banks typically face? What is the impact on NI and NII over two years in each case?

6. Suppose a bank advances $5m worth of loans that is financed by issuing $5m worth of liabilities, each with a maturity of two years. What will happen to NII if:

(a). The rates charged on all the assets are variable and the rates paid on all the liabilities are fixed, and market rates of interest fall?

(b). The rates charged on all the assets are fixed and the rates paid on all the liabilities are variable, and market rates of interest fall?