QUESTION 1

As a financial analyst, you are to provide your advice to an investor about the situation of the following two banks and help him decide which bank is a better option for investment. Bank of Altor has assets composed solely of a 10-year, 12 percent coupon, RM1 million loan with a 12 percent yield to maturity. It is financed with a 10-year, 10 percent coupon, RM1 million bond with a 10 percent yield to maturity. Bank of Lowell has assets composed solely of a 7-year, 12 percent, zero-coupon bond with a current value of RM894,006.20 and a maturity value of RM1,976,362.88. It is financed by a 10-year, 8.275 percent coupon, RM1,000,000 face value bond with a yield to maturity of 10 percent. All securities except the zero-coupon bond pay interest annually.

Required:

If interest rates rise by 1 percent, how do the values of the assets and liabilities of each bank change? What accounts for the differences between the two banks accounts?