Suppose Levered Bank is funded with $2\mathrm{.}0\%$ equity and $98\mathrm{.}0\%$ debt. Its current market capitalization is $$10\mathrm{.}00$ billion, and its market$-$to$-$book ratio is $1\mathrm{.}0.$ Levered Bank earns a $4\mathrm{.}22\%$ expected return on its

assets $($the loans it makes$),$ and pays $4\mathrm{.}0\%$ on its debt.

New capital requirements will necessitate that Levered Bank increase its equity to $4\mathrm{.}0\%$ of its capital structure. It will issue new equity and use the funds to retire existing debt. The interest rate on its debt is

expected to remain at $4\mathrm{.}0\%.$

a$.$ What is Levered Bank's expected ROE with $2\mathrm{.}0\%$ equity?

b$.$ Assuming perfect capital markets, what will Levered Bank's expected ROE be after it increases its equity to $4\mathrm{.}0\%?$

c$.$ Consider the difference between Levered Bank's ROE and its cost of debt. How does this "premium" compare before and after the Bank's increase in leverage?

d$.$ Suppose the return on Levered Bank's assets has a volatility of $0\mathrm{.}25\%.$ What is the volatility of Levered Bank's ROE before and after the increase in equity?

The ROE is $6.($Round to two decimal places.$)$

b$.$ Assuming perfect capital markets, what will Levered Bank's expected ROE be after it increases its equity to $4\mathrm{.}0\%?$

The new ROE is

$\%.($Round to two decimal places.$)$

c$.$ Consider the difference between Levered Bank's ROE and its cost of debt. How does this "premium" compare before and after the Bank's increase in leverage?

The premium before the increase is

$\%.($Round to two decimal places.$)$

The premium after the increase is

$\%.($Round to two decimal places.$)$

d$.$ Suppose the return on Levered Bank's assets has a volatility of $0\mathrm{.}25\%.$ What is the volatility of Levered Bank's ROE before and after the increase in equity?

The volatility before the increase is $\%.($Round to two decimal places.$)$

The volatility after the increase is

$\%.($Round to two decimal places.$)$

e$.$ Does the reduction in Levered Bank's ROE after the increase in equity reduce its attractiveness to shareholders? Explain.

premium and risk both fall bv

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