What is return to equity if expected pay off of investment

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Reference no: EM132705164

Consider XYZ Bank that is established with $1500bn of deposits and $I000bn of equity. Its assets are some investments that are expected to pay off $2750bn in 1 years' time. Suppose the rate of interest on safe assets is 10% a year and there is no risk premium to hold risky assets like XYZ Bank's investments.

Problem 1. Suppose very shortly after being established the bank finds that it has been too optimistic And now expects its investments to pay off $2475bn in 1 year time. What is the return to equity in the bank?

A. -25%
B. -50%
C. -87.5%
D. -100%
E. None of A-D

Problem 2. Suppose instead that the bank's liabilities were initially $2000 bn of deposits with the rest Being equity. Now what is the return to equity if the expected pay off of its investments falls to $2475bn in 1 year time?

A. -25%
B. -50%
c. -87.5%
D. -100%
E. None of A-D

Reference no: EM132705164

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