Leverage is defined as: L=Assets/Equity (asset-to-equity ratio).

Bank 1 Figure 1 Network of banks (5) Now let's consider what luppets to accomy in which there are four link as illustrated in Figure 1. The arrows represent posure. For instance, bank 2 is exposed to bank 1 (there is an arrow from bank 2 to bank 1), and that means bank 2's assets contain securities (debt or equity) issued by bank 1 Suppose ench bank's balance sheet is of the following form Assets Liability 20% in boots 1 - ) fraction in debit Equity BV in bank-issued securitas fraction in equity For instance, 80% of bank 2's assets are curities iesund by bank 1: 80% of bank 3's assets are securities issued by bank 2 and etc. (follow the arrows in Figure 1). The lowas held by different banks are all separate from each other. Throughout this question, you don't need to think in dollar values, but only need to think about values in proportional terms les fons are 20% of total asset value in the balance sheet above Recull how investors are paid in akrapteyifunkgoes bankrupt, then its equity becomes worthless and its debt hoes get all remaining asset value with a haircut" For instance, suppo L - 100 euity is 10% of total Assets), and suppose the asset value of a bank declines w 30%. Then, ito bankrupt, and its equity becomes worth its debt is now worth = is much as before. So the holders of its quite sur les of 100% (thless now), and the holders of its debt suffer a proportional loss of 1-1 = 22.2% In all sub-questions below, we want to figure out what happens if bank 1 suffers a negative shock: the value of its own suddenly becomes to The For instance, 80% of bank 2's assets are securitas issued by bank 1: Su% of 2 banke 3's assets are securities issued by tank 2 and etc. (Sollow the crows in Figure 1). The loans held by different banks are all separate from each other. Throughout this question, you don't need to think in dollar values, but only need to think about values in proportional terms (eg loans are 20% of total asset value in the balance sheet above) Recall how investors are paid in bankruptcy: if a bank poes bankrupt, then its equity becomes worthless, and its det holders get all remaining asset value with a haircut". For instance, suppose L = 10 sequity is 10% of total assets). and suppose the asset value of a bank declines by 37. Then, it goes bankrupt, and its equity becomes wethless. Its debt is now worth as much as before. So the holders of its equity suffer a loss of 100% (worthless now), and the holders of its debt suffer a proportional loss of 1-1-1= 2.28. In all sub-questions below, we want to figure out what happens if bank1 suffers a negative shock: the value of its loans saddenly becomes to. The bank-issued securities on lank 1 balance sheet is not affected, and the loans held by other banks are also not affected.) For simplicity, suppose all four banks have the same leverage ratio of L before the negative shocked happened. Please awer the questies below. i. How high can the bewage tatio I. be for there to be nolunkruptcy among all four banks in response to this negative shock I. Now supposebatiks hold debt securities ined by other butikes Sup pose all banks have a beverage ratio of L=15. How many tanks will go bankrupt? Please be specific in your answer which tuinks are bankrupt and why. Support your answer with calculations Hint: there is a "chain reaction". When butik 1 gets the negative shock, the value of its equity and its ability to pay back debt may be affected. That will impact the set values of bank 2. because lank holis securities issued by tank 1. And then that impacts hank 3, and so on.. ii. Still assume that I = 15 for all banks. Now suppose banks hold equity securities issued by other banks. How many bunles will go bankrupe? iv. What do you learn from the provints three questions? Please focus on how inter-bank relationships impact the likelihood of widespread bank failures. (There is no absolutely correct answer, even though there are better answers. You will receive full credit as long as you provide a thoughtful answer.) This is bank 1 does not a bankrupt The sot of bank stare debt dank 1 stk sebeby Iwak 2 te Bank 1 Figure 1 Network of banks (5) Now let's consider what luppets to accomy in which there are four link as illustrated in Figure 1. The arrows represent posure. For instance, bank 2 is exposed to bank 1 (there is an arrow from bank 2 to bank 1), and that means bank 2's assets contain securities (debt or equity) issued by bank 1 Suppose ench bank's balance sheet is of the following form Assets Liability 20% in boots 1 - ) fraction in debit Equity BV in bank-issued securitas fraction in equity For instance, 80% of bank 2's assets are curities iesund by bank 1: 80% of bank 3's assets are securities issued by bank 2 and etc. (follow the arrows in Figure 1). The lowas held by different banks are all separate from each other. Throughout this question, you don't need to think in dollar values, but only need to think about values in proportional terms les fons are 20% of total asset value in the balance sheet above Recull how investors are paid in akrapteyifunkgoes bankrupt, then its equity becomes worthless and its debt hoes get all remaining asset value with a haircut" For instance, suppo L - 100 euity is 10% of total Assets), and suppose the asset value of a bank declines w 30%. Then, ito bankrupt, and its equity becomes worth its debt is now worth = is much as before. So the holders of its quite sur les of 100% (thless now), and the holders of its debt suffer a proportional loss of 1-1 = 22.2% In all sub-questions below, we want to figure out what happens if bank 1 suffers a negative shock: the value of its own suddenly becomes to The For instance, 80% of bank 2's assets are securitas issued by bank 1: Su% of 2 banke 3's assets are securities issued by tank 2 and etc. (Sollow the crows in Figure 1). The loans held by different banks are all separate from each other. Throughout this question, you don't need to think in dollar values, but only need to think about values in proportional terms (eg loans are 20% of total asset value in the balance sheet above) Recall how investors are paid in bankruptcy: if a bank poes bankrupt, then its equity becomes worthless, and its det holders get all remaining asset value with a haircut". For instance, suppose L = 10 sequity is 10% of total assets). and suppose the asset value of a bank declines by 37. Then, it goes bankrupt, and its equity becomes wethless. Its debt is now worth as much as before. So the holders of its equity suffer a loss of 100% (worthless now), and the holders of its debt suffer a proportional loss of 1-1-1= 2.28. In all sub-questions below, we want to figure out what happens if bank1 suffers a negative shock: the value of its loans saddenly becomes to. The bank-issued securities on lank 1 balance sheet is not affected, and the loans held by other banks are also not affected.) For simplicity, suppose all four banks have the same leverage ratio of L before the negative shocked happened. Please awer the questies below. i. How high can the bewage tatio I. be for there to be nolunkruptcy among all four banks in response to this negative shock I. Now supposebatiks hold debt securities ined by other butikes Sup pose all banks have a beverage ratio of L=15. How many tanks will go bankrupt? Please be specific in your answer which tuinks are bankrupt and why. Support your answer with calculations Hint: there is a "chain reaction". When butik 1 gets the negative shock, the value of its equity and its ability to pay back debt may be affected. That will impact the set values of bank 2. because lank holis securities issued by tank 1. And then that impacts hank 3, and so on.. ii. Still assume that I = 15 for all banks. Now suppose banks hold equity securities issued by other banks. How many bunles will go bankrupe? iv. What do you learn from the provints three questions? Please focus on how inter-bank relationships impact the likelihood of widespread bank failures. (There is no absolutely correct answer, even though there are better answers. You will receive full credit as long as you provide a thoughtful answer.) This is bank 1 does not a bankrupt The sot of bank stare debt dank 1 stk sebeby Iwak 2 te