If the rate currently payable on 10-year Treasury bonds is 4.3 percent and the r

Question

If the rate currently payable on 10-year Treasury bonds is 4.3 percent and the risk spread is 3 percent, what is the average rate on other forms of commercial lending?

Instructions: Round your answer to one decimal place.

___ percent.

The table below shows the balance sheet of a bank in millions of dollars.

Instructions: Round your answers to the nearest dollar.

a. The bank’s net worth is $___ million.

b. Assume housing prices increase and defaults on subprime mortgages rise, causing the bank’s assets in subprime mortgages to decrease from 500 to 350.

     The bank’s new net worth is $__ million.

     Total assets are now $__ million.

c. Using the net worth calculated in part (a), for the bank to be insolvent (that is, for liabilities to be greater than assets), the value of subprime
mortgages have to fall by (Click to select)moreless than $__ million.

Assets (in millions) Liabilities (in millions)   Cash                                $ 800   CDs                         $2,000   Commercial loans              2,000   Savings accounts       1,500   Consumer loans                   800   Long-term debt           1,000   Prime mortgages                  800   Subprime mortgages             500   Total assets                    $4,900      Total liabilities           $4,500

Explanation / Answer

(1) Average risk of other bonds = Treasury bill return + Risk spread = 4.3% + 3% = 7.3%

(2)

(a) Net worth = Total assets - Total liabilities = $(4,900 - 4,500) billion = $400 million

(b) This reduces total assets by $(500 - 350) million = $150 million

So, Net worth also reduces by $150 million & new net worth = $(400 - 150) million = $250 million

New total asset = $(4,900 - 150) = $4,750 million

(c) Subprime mortage has to fall by more than $400 million.

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