A financial institution has the following market value bal

ance sheet structure: $($LG $20-1)$

Assets

Liabilities and Equity

Cash

$$1,000$ Certificate of deposit

$$10,000$

Bond

$10,000$ Equity

$1,000$

Total assets $$11,000$ Total liabilities and equity $$11,000$

The bond has a $10-$year maturity, a fixed$-$rate coupon of $10$percent paid at the end of each year, and a par value of $$10,000.$ The certificate of deposit has a $1-$year matu rity and a $6$percent fixed rate of interest. The FI expects no additional asset growth. What will be the net inter est income $($NII$)$ at the end of the first year? $($Note: Net interest income equals interest income minus interest expense.$)$

If at the end of year $1$ market interest rates have increased $100$ basis points $(1$percent$),$ what will be the net interest income for the second year? Is the change in NII caused by reinvestment risk or refinancing risk?

Assuming that market interest rates increase $1$ per cent, the bond will have a value of $$9,446$ at the end of year $1.$ What will be the market value of the equity for the FI$?$ Assume that all of the NII in part $($a$)$ is used to cover operating expenses or is distributed as dividends.

If market interest rates had decreased $100$ basis points by the end of year $1,$ would the market value of equity be higher or lower than $$1,000?$ Why?

What factors have caused the changes in operating per formance and market value for this FI$?$