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Question 2: (Gap analysis) Suppose that a bank has an asset holding of $1 billion. The capital requirement is 8%. If the bank holds the
Question 2: (Gap analysis) Suppose that a bank has an asset holding of $1 billion. The capital requirement is 8%. If the bank holds the minimal amount of capital. a) What is the size of bank liabilities? What is the bank leverage? Suppose the bank holds 80% of their asset in long-term loans, and 20% in short-term bonds. For loans and bonds, the bank is paid an interest rate of 10%. Moreover, all bank liabilities are short- term deposits and the bank pays a 3% interest rate. b) Plot the bank's balance sheet. c) What is the bank's profit? (Note: If you are unable to calculate the size of bank liabilities, assume it is X.) d) Now if the short term interest rate increases by 2% (affecting the interest rate of short- term bonds and of the short-term deposits), by how much does the bank profit increases or decreases? Give an intuition. Is the bank more or less risky than before? Why? e)
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