Question

Consider the balance sheet of the Bank of America

ASSETS LIABILITIES

Rate-sensitive assets $50 million Rate-sensitive liabilities $70 million

Fixed-rate assets $50 Fixed-rate liabilities $30 million

Suppose that interest rates rise by 1 percentage points on average, from 4% to 5%

a. How will the increase in interest rates affect income on the assets?

b. How much will the increase in interest rates affect payments on the liabilities?

c. What has happened to the bank’s profits as a result of this interest rate increase?

d. Does this example prove that the bank suffers from interest-rate risk? Why or why not?

Answer #1

**Solution to
part (a):**

Increase in interest rates will increase the interest income by $50 million * 1% = $500,000.

**Solution to
part (b):**

Increase in interest rates will increase the interest expense by $70 million * 1% = $700,000.

**Solution to
part (c):**

As a result of increase in interest rate profits will decrease by $200,000 ($700,000 - $500,000)

**Solution to
part (d):**

This example prove that the bank suffers from interest-rate risk. Due to change in interest-rate there was a decrease in profits of the Bank.

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