Question

QUESTION 4

(e) A taxable security offers a before- tax return of 30%. If the tax rate is 35%; find how
much this security must offer to make it equally attractive as a tax-exempt security

(f ) List Four types of risk which lenders and providers of funds face and which could be
reasons for bank failures

Answer 1

Question 4 )

Part E )

Before-tax return = 30%

Tax rate = 35%

If the security has to offer 30% after tax return then before tax return should be 30% / (1-tax rate) = 30% /(1-0.35) = 46.15%

Part F)

These are different types of risk that a bank faces and that might lead to bank failure-

1. Systematic risk- This is the risk that affects the whole economy and that might hit banks e.g. 2008 crisis, Covid-19 situation

2. Market risk- This risk is due to the change in the prices in the market

3. Default risk- This is the risk that the customer might default on the loan

4. Interest risk- This risk is associated with the interest rate fluctuations