If a bank raises its equity multiplier, which of the following rise? both its return on...

If a bank raises its equity multiplier, which of the following rise?

both its return on equity and its risk of bankruptcy

its return on equity, but not its risk of bankruptcy

its risk of bankruptcy, but not its return on equity

Neither its rate of return on equity nor its risk of bankruptcy.

Expert Solution

If the bank raises its equity multiplier then “both its return on equity and its risk on bankruptcy”

Equity multiplier = Assets / equity

Higher equity multiplier means that the bank using more leverage in its balance sheet. Higher leverage will result in increase in return or profit on equity deployed in the balance sheet but the risk of default in the loans “asset side” will too can cause higher chance of bank becoming insolvent and bankrupt as default in loans will wipe out the equity of the bank.

Rahul Sunny answered 2 years ago

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