Suppose an investment bank is buying $50 million in long-term mortgage-backed securities,and finances the investment by borrowing 80% and paying for the other 20% out of equity.What is the bank's return on its equity investment if the value of the mortgage-backed securities increases by 10% during the year after they are purchased?

Question

Quizplus · Accepted Answer

The bank is borrowing 80% of the $50 million investment, which means it is borrowing $40 million. The remaining 20% is funded by equity, which is $10 million.

If the value of the investment increases by 10%, the investment will be worth $55 million.

The bank's total investment (including the borrowed amount) is $50 million, so the increase in the value of the investment is $5 million.

The return on equity investment can be calculated by dividing the increase in the value of the investment by the amount of equity invested:

Return on equity investment = ($5 million increase / $10 million equity) x 100% = 50%

Therefore, the bank's return on its equity investment is 50%.

Suppose an Investment Bank Is Buying $50 Million in Long-Term