Reference no: EM133118739
1) Suppose that, at time t = 0 (now), 225 depositors (householders) deposit $1,000 each to a fictitious bank, call it OUR Bank. The deposits have one-year maturity and the bank pays 4% annual interest rate. The OUR Bank pools all the deposits, and lends $75,000 each to THREE corporations. The loan terms are following: Maturity = 6 years, and Fixed interest rate is 8% per annum simple interest; it is the "Interest ONLY" loan for the first three-years of the maturity of loan, after that the principal amount needs to be repaid in three equal installments. In other words, the principal amount has to be repaid in three equal installments at the end of the Year 4, Year 5, and Year 6 of the loan maturity. (Remember, the interest is computed on the outstanding principal balance.) In addition, the owners have put $6,000 of initial equity capital. For exposition, we will make additional assumptions: No taxes, no dividend payments, no time value of money (bank will not reinvest the interest income). The OUR Bank will cease to exist after six years.
Make the following three assumptions:
(1) Short-term (one-year) interest rate remains at 4% per annum for the next six years.
(2) All three borrowers do not default on their loan obligations.
(3) All depositors (225 depositors) renew their one-year deposits throughout the six years, but consume the interest payments. In other words, no principal withdrawals and no addition of principal from the depositors for the next six years. In addition, the OUR Bank MUST accept all the deposits from the 225 depositors for each of the six years, including Year 4, Year 5, and Year 6.
What will be the equity position in US dollar of OUR Bank at the end of six years, t = 6 year, that also includes the initial owners' equity? [For clarification: The bank issues loans only at t=0, after that, throughout the next six years, OUR Bank is not issuing any additional loan or investing cash for short-term purpose. In other words, OUR Bank does not earn additional income on its annual net interest income. This clarification is required so that we all have a common correct answer.]
[Make sure to add, the initial owner equity.]
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