This scenario applies to Questions 1 and 2. Suppose you like the look of BofA's ROE and consider buying some shares on the New York Stock Exchange (NYSE:BAC). However, you are concerned about the Federal Reserve increasing interest rates in 2022 and beyond, and how this might affect BofA's profitability.

Question 1:

Briefly explain how higher interest rates could lead to a reduction in BofA's net interest income in the short-term.

In your answer, please concentrate on the impact of higher interest rates on the two components that make up net interest income (interest income and interest expense); and assume that the overall volume of the bank's assets and liabilities will not be impacted by the interest rate change in your analysis.

Please also address how the characteristics of assets (investments) and liabilities (debt funding) currently held by the bank contribute to this outcome.

Question 2:

If BofA anticipated additional increases in interest rates in 2022 (and future years), what steps could it take now (before additional interest rates increases) to avoid a possible drop in its net interest income in the future, as described in Question 39? Please explain and give two examples (one for liabilities and one for assets).