please give answers to each questions with clear steps. and please writing or ty
ID: 2790271 • Letter: P
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please give answers to each questions with clear steps. and please writing or typing the answers clearly, it is better to type the answers, many thanks!
Think of a Bank that has 1100 in assets. These assets are split between 100 in reserves at the central bank and 1000 in loans to houses. The equity of the bank is 200 and deposits are 900. If return on assets (ROA) is 3% and house prices fall by 10% then how will this affect the return on equity (ROE) of the bank? If the real interest rate is 2% how was the risk premium affected? 7. (10 marks.)Explanation / Answer
Using Dupont Analysis
ROE = ROA * Leverage = ROA * (Avg. Total Asset/Avg. Total Equity)
Now, ROA is 3% but housing prices fall 10%. It means the 1000 given to loans to houses is cost 900 now. To match the Asset = Liability + Owner's Equity, the equity will come down 100 since, deposit of 900 as liability can't be reduced.
1000 = 100 + 900
Therefore, Leverage would be = 1000/100 = 10 times
ROE = ROA * Leverage = 3%*10 = 30%
If the asset price of house loan would have not come down then ROE would have been
ROE = 3%* (1100/200) = 3%*5.5 = 16.5%
The change is 30 - 16.5 = 13.5%
The risk premium is the additional return the investor would receive from his expected return, since real interest rate is 2% so, risk premium is 13.5 - 2 = 11.5%
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