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1. \"Life is Good\" Bank or LG Bank has $15 million in Cash and $85 million in loans made. Their total deposit received is $80 million and a net worth of $20 million. Now consider two separate scenarios: A. Two of their borrowers declared bankruptcy, and Bank LG has no hope of recovering $20 million of loans back. Show Bank LG's Balance Sheet, before and after the adjustments made. Now: Assets | | | | | Liabilities After Bankruptcy: Assets | | | | | Liabilities What kind of risk did the bank experience? [For example: Credit Risk, or Liquidity Risk, or Interest Rate Risk] B. Consider a different scenario (ignore above Q#1A). Due to a panic in the financial market, $25 million is withdrawn by customers of LG. Now, Bank LG can liquidate its loan in short notice by receiving 90 cents to a $. Show Bank LG's Balance Sheet, before and after the adjustments are made. Now: Assets | | | | | Liabilities After Panic: Assets | | | | | Liabilities What kind of risk did the bank experience? [For example: Credit Risk, or Liquidity Risk, or Interest Rate Risk] 2. Bank 1 made $300million of floating rate loans yielding the T-bill rate plus 3%. They also issued fixed rate Certificates of Deposits (CD) offering 10% interest. Bank 2 made $300 million of fixed rate mortgages at 12% interest rates. They pay T-Bill plus 1% interest on their savings account. A. Who is adversely affected: When interest rates go down? Why? When interest rates go up? Why? B. To hedge both the banks decided to enter into a swap agreement with each other for a notional amount of $300 million. Which bank will buy swap? Who Bank will sell a swap? C. Propose a swap that hedges both the banks from interest rate risk. What is NII of Bank 1? What is NII of Bank 2? What is their combined NII? D. How should they distribute their combined NII? (You may suggest any distribution as long as that is reflected in the swap) E. Suggest a Swap: Receives: Pays: Bank 1 Bank 2 F. After Swap agreement, show by entering each cash flow the estimate for: For Bank 1: Asset Income: Cost of Funding: NII after Swap For Bank 1: Asset Income: Cost of Funding: NII after Swap Show Bank's NII in $, for each year Year T-Bill Rate 1 3.0% 2 3.5% 3 4.0% Asset Income Bank 1 Liabilities Pay Swap Receive Swap Pay Net $ Bank 2 Liabilities Pay Swap Receive Swap Pay Net $ Show Bank's NII in $, for each year Year T-Bill Rate 1 3.0% 2 3.5% 3 4.0% Asset Income