Question 2 (11 marks, 500 words limit) You work at Lake Bank, a bank that lends exclusively to consumers. Despite recent tightening by the central bank and increased competition from non-bank lenders its aim is to offer the lowest mortgage rates in the market to its clients. Lake Bank can issue $50 million in mortgages this month and is presented with the following funding options.

Type Maturity Interest rate CD 1 year 1.45% Bond 10 years 1.90% Bond 20 years 2.50%

a. Your superior is convinced that the 1-year CD is the best option (lowest cost). Develop a short thesis as to why the 1-year CD may not be the best option. (3 marks)

Assume now that you can convince your superior, and the bank selects the 10-year bond instead. You know that operating costs are $30 million, assets are $400 million, earning assets are $320 million, risk-weighted assets are $300 million, the tax rate is 25%, shareholders require a 15% ROE, and shareholders equity is $20 million.

b. Compute the mortgage interest rate you charge that accounts for overhead costs and shareholders required rate of return. (4 marks) c. Do you think this is the interest rate the bank will charge? Why (not)? (4 marks)