A bank that finances long-term fixed-rate mortgages with short-term deposits is exposed to
A)increases in net interest income and decreases in the market value of equity when interest rates fall.
B)decreases in net interest income and decreases in the market value of equity when interest rates fall.
C)decreases in net interest income and increases in the market value of equity when interest rates increase.
D)increases in net interest income and increases in the market value of equity when interest rates increase.
E)decreases in net interest income and decreases in the market value of equity when interest rates increase.

Question

Quizplus · Accepted Answer

A bank that finances long-term fixed-rate mortgages with short-term deposits is exposed to interest rate risk. When interest rates increase, the bank will have to pay higher interest rates on deposits, which will decrease their net interest income. On the other hand, the market value of equity will increase due to the higher interest rates. When interest rates fall, the bank's net interest income will also decrease as they will receive less interest on their assets. Additionally, the market value of equity will decrease due to the lower interest rates. Therefore, the best choice is E.

A Bank That Finances Long-Term Fixed-Rate Mortgages with Short-Term Deposits