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Question - A financial institution has the following balance sheet structure:
Assets
USD million
Liabilities
Cash
10
equity
30
Bond
100
certificate of deposit
Real Estate
20
TOTAL
130
Total
The USD 100 million bond has a three year maturity paying 10 percent interest per year. The USD 100 million certificate of deposit has a two-year maturity and paying 8 percent interest per year. The bond and certificate of deposit will be rolled over after their maturities at the respective prevailing market rates. The financial institution expects no additional asset growth.
Required -
1. What will be the financial institution's net interest income (NII) over the five-year investment horizon if the interest rate decreases by 1 percent per annum after the first year and decreases by 1 percent per annum after the third year?
2. What will be the financial institution's net interest income (NII) over five-year investment horizon if the interest rate increases by 1 percent per annum after the second year and increases by 1 percent per annum after the fourth year?
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