How do firm-specific credit risk and systematic credit risk differ? How can an

FI alleviate firm-specific credit risk?

#2Provide a definition of refinancing risk? How is refinancing risk part of interest rate risk? If an FI funds long-term fixed-rate assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest?

#3Provide a definition of reinvestment risk? How is reinvestment risk part of interest rate risk? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest? An increase in the rate of interest?

#4A financial institution has the following market value balance sheet structure:

AssetsLiabilities and Equity

Cash$2,000Certificate of deposit$10,000

Bond$10,000Equity $2,000

Total assets$12,000Total liabilities and equity$12,000

a.The bond has a 30-year maturity, a fixed-rate coupon of 8 percent paid at the end of each year, and a par value of $10,000. 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?

#5A bank invested $100 million in a two-year asset paying 10 percent interest per year and simultaneously issued a $100 million, one-year liability paying 8 percent interest per year. The liability will be rolled over after one year at the current market rate. What will be the banks net interest income if at the end of the first year all interest rates have increased by 1 percent (100 basis points)?