A financial institution has the following market value balance sheet structure:

Assets				Liabilities and Equity
Cash	$	2,400		Certificate of deposit	$	11,400
Bond		10,200		Equity		1,200
Total assets	$	12,600		Total liabilities and equity	$	12,600

a. The bond has a 10-year maturity, a fixed-rate coupon of 12 percent paid at the end of each year, and a par value of $10,200. The certificate of deposit has a 1-year maturity and a 6 percent fixed rate of interest. The FI expects no additional asset growth. What will be the net interest income (NII) at the end of the first year? (Note: Net interest income equals interest income minus interest expense.) b. 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? c. Assuming that market interest rates increase 1 percent, the bond will have a value of $9,677 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. d. 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 $1,200? e. What factors have caused the changes in operating performance and market value for this FI?

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 $1,200? (Negative amounts should be indicated by a minus sign.)

The bond has a 10-year maturity, a fixed-rate coupon of 12 percent paid at the end of each year, and a par value of $10,200. The certificate of deposit has a 1-year maturity and a 6 percent fixed rate of interest. The FI expects no additional asset growth. What will be the net interest income (NII) at the end of the first year? (Note: Net interest income equals interest income minus interest expense.)

Net interest income (NII)

$612

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?

Net interest income (NII)	$510
Is the change in NII caused by	Refinancing risk

Assuming that market interest rates increase 1 percent, the bond will have a value of $9,677 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.

What will be the market value of the equity for the FI

$677

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 $1,200? (Negative amounts should be indicated by a minus sign.)

The market value of the equity would be			higher			because the value of the bond would be
higher		and the value of the CD would			remain unchanged