Question

A commercial bank has $100 of fixed-rate liabilities and $50 of fixed-rate assets. If the interest rate decreases from 10% to 5%, the change in net profit is (   ).

a. $2.5

b. $25

c. $0

d. $-2.5

Answer 1

Given that,

Earlier, Liabilities = $100 ans Assets =$50

Interest rate =10%

Hence,

interest on liabilities to be paid = liabilities×interest%

Interest on liabilities to be paid= $100×10% = $10

Interest on Assets to be recieved = assets× interest%

Interest on assets to be recieved =$50×10% = $5

• Hence net loss = interest to be paid- interest to be recieved = $10--$5 = $5 (loss as paid is more than recieved.

Now, everything else remains same but interest rate now =5%

Similar to above,

interest to be paid = $100×5% = $5

Interest to be recieved =$50×5%= $2.5

• Net loss = interest to be paid- interest to be recieved = $5-$2.5 = $2.5( new loss, it is a loss because still interest paid is more than interest recieved)

Change is: $5 (earlier loss) - $2.5(now loss) = $2.5(loss)

It is still a loss and not profit. There is a reduction in loss by $2.5. Hence ans-(d)