Question: Consider the following two banks: (LG 3-4) Bank 1 has assets composed solely of a 10-year, 12 percent coupon, $1 million loan with a 12 percent yield to maturity. It is financed with a 10-year, 10 percent coupon, $1 million CD with a 10 percent yield to maturity. Bank 2 has assets composed solely of a 7-year, 12 percent, zero-coupon bond with a current value of $894,006.20 and a maturity value of $1,976,362.88. It is financed by a 10-year, 8.275 percent coupon, $1,000,000 face value CD with a yield to maturity of 10 percent. All securities except the zero-coupon bond pay interest annually.
a. If interest rates rise by 1 percent (100 basis points), how do the values of the assets and liabilities of each bank change?
b. What accounts for the differences between the two banks' accounts? Please show calculations and formulas.