"question 1: a bank with a two-year investment horizon has issued a one-year certificate of deposit for $50 million at an intere
st rate of 2 percent. with the proceeds, the bank has purchased a two-year treasury note that pays 4 percent interest. what risk does the bank face in entering into these transactions? what would happen if all interest rates were to rise by 1 percent? question 2: why do you think that u.s. banks are prohibited from holding equity as part of their own portfolios?"
Explanation: Bank is faced with the risk of monetary value of Treasury note may fall. After one year, the bank must make sure that the funds are available at hand. funds made available by banks are being sold at the end of the first year.With the fall in value, there might be a capital loss which is a risk that may occur.
The bank will need to absorb a capital loss peradventure if the value of asset drops . Then capital loss could be greater than 2%, given that the value of asset fall further below.
Meaning, the case will again be the same, if the interest rate increased by 1%..
if all interest rates were to rise by 1 percent? there shall be no effect on Profits.
The bank faces the risk that the short-term interest rate will increase (Rise) before the second year, this will increase the amount of interest the bank has to pay on the CD but there will be no changes in the interest income that the bank receives from the Treasury.
Annual income of bank = Annual interest on Treasury note = $50000000 * 4% = $2000000
Annual expense of bank = Annual interest on CD= $50000000 * 2% = $1000000
Annual Profit for Bank = $2000000 - $1000000 = $1000000
3. If all interest rate rises by 1% then:
Annual income of bank = Annual interest on Treasury note = $50000000 * 5% = $2500000
Annual expense of bank = Annual interest on CD= $50000000 * 3% = $1500000
Annual Profit for Bank = $2500000 - $1500000 = $1000000
The illustration or example given above is an example of
glass precipice. A glass precipice is a type of metaphor illustration that
depicts an effect that is not seen or visible when in terms of the employability
of a person or an individual.