Suppose Levered Bank is funded with 2.2% equity and 97.8% debt. Its current market capitalization is $10.36 billion, and itsmarket-to-book ratio is 0.8. Levered Bank earns a 4.18% expected return on its assets(the loans itmakes), and pays 3.8% on its debt.

New capital requirements will necessitate that Levered Bank increase its equity to 4.4% 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 3.8%.

a. What is LeveredBank's expected ROE with 2.2% equity?

b. Assuming perfect capitalmarkets, what will LeveredBank's expected ROE be after it increases its equity to 4.4%?

c. Consider the difference between LeveredBank's ROE and its cost of debt. How does this"premium" compare before and after theBank's increase inleverage?

d. Suppose the return on LeveredBank's assets has a volatility of 0.22%. What is the volatility of LeveredBank's ROE before and after the increase inequity?

e. Does the reduction in LeveredBank's ROE after the increase in equity reduce its attractiveness toshareholders? Explain.