Question

1) A bank with a leverage ratio of 20 has a cost of debt of 1.5%pa and a portfolio of assets with an expected yield of 3.5%pa. What are the expected ROA net of debt funding costs and the expected ROE of the bank, using the approach to defining leverage taken in the lecture slides? Show your workings.

2) What will the ROA and ROE actually be if the yield on assets turns out to be 3%? Show your workings. (1 mark)

3) What will the ROA and ROE actually be if the yield on assets turns out to be 1%? Show your workings.

4) Redo the above calculations in parts 1) and 3) for a leverage ratio of (i) 10 (ii) 30? What effect does a higher leverage ratio have on your answers? Show your workings.

5) What is the relationship between a bank’s capital ratio and the risks and returns faced by (i) its depositors and (ii) its shareholders? Explain your answers.

Answer 1