Accounting for Interest Rate Risk

1 Consider an economy with one bank. The bank holds $100M in reserves, $490M in loans, $100M in investments in two-year zero coupon bonds and $150M in investments in Netflix stock. They have taken in $600M in deposits.

1. a (4 points) Show the T-Account for this bank. Be sure to calculate bank capital!

2. b (2 points) If the reserve ratio is 5%, what is the dollar value of deposits that consumers could withdraw and allow the bank to remain in compliance with their required reserves? Assume they pay depositors by depleting their reserves.

3. c (1 points) Suppose that Netflix is currently trading for $50 per share. If the market interest rate (the banks required return) is 6% and you predict a growth rate of 1%, what dividend must Netflix be paying. You can quote the dividend at time t or time t + 1. How many shares does the bank own?

4. d (1 points) If the market interest rate is 6% and the bank anticipates the interest rate rising to 8% next year, what must the interest rate be on the banks two-year bonds if they are using the Expectations Theory to price their bonds?

5. e (2 points) If the market interest rate increases to 15%, what is the new price of these bonds? What happens to the price of the stock?

6. f (3 points) What happens to the banks T-Account after this change in the interest rate? Show this in a new T-Account. Is the bank still solvent?