1. A bank invested $50 million in a two-year asset paying 10 percent interest per year and simultaneously issued a $50 million, one-year liability paying 8 percent interest per year to pay for it. Is the bank short funded or long funded? What is the bank’s net interest income in year one? What will be the bank’s net interest income in year one and year two if at the end of the first year all interest rates have increased by 2 percent?
2. A common example of the asset transformation process is when banks take short-term deposits and “transform” them into long-term mortgage loans. Is this example considered to be short funded or long funded? Would the bank be exposed to refinancing risk or reinvestment risk? What movement in interest rates will negatively impact the bank?