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A bank's only asset is a peculiar 3-year, 6% $100 million bond where payments are paid at the end of years 2 and 3, The
A bank's only asset is a peculiar 3-year, 6% $100 million bond where payments are paid at the end of years 2 and 3, The term structure is flat with all yields equal to 6%. The bank's liability includes 1-year debt that promises to pay out $84.80 after a year, implying that the debt value today is 84.80/1.06 = $80. The bank in question 1 (asset = 3-year, 6% $100 million bond where payments are paid at the end of years 2 and 3, flat term structure with all yields = 6%, 1-year debt that pays out $84.80 after a year) faces a sudden 50 basis points hike by the Fed, which moves all yields to 6.5%. The bank's equity value
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