Suppose Levered Bank is funded with 1.6 % equity and 98.4 %debt. Its current market capitalization is â$9.72 âbillion, anditsâ market-to-book ratio is 1.1. Levered Bank earns a 4.23 %expected return on its assetsâ (the loans itâ makes), and pays 3.6% on its debt. New capital requirements will necessitate thatLevered Bank increase its equity to 3.2 % of its capital structure.It will issue new equity and use the funds to retire existing debt.The interest rate on its debt is expected to remain at 3.6 %. a.What is Leveredâ Bank's expected ROE with 1.6 % âequity? b.Assuming perfect capitalâ markets, what will Leveredâ Bank'sexpected ROE be after it increases its equity to 3.2 %â? c.Consider the difference between Leveredâ Bank's ROE and its cost ofdebt. How does thisâ "premium" compare before and after theâ Bank'sincrease inâ leverage? d. Suppose the return on Leveredâ Bank'sassets has a volatility of 0.26 %. What is the volatility ofLeveredâ Bank's ROE before and after the increase inâ equity? e.Does the reduction in Leveredâ Bank's ROE after the increase inequity reduce its attractiveness toâ shareholders? Explain.
Suppose Levered Bank is funded with 1.6 % equity and 98.4 %debt. Its current market capitalization is â$9.72 âbillion, anditsâ market-to-book ratio is 1.1. Levered Bank earns a 4.23 %expected return on its assetsâ (the loans itâ makes), and pays 3.6% on its debt. New capital requirements will necessitate thatLevered Bank increase its equity to 3.2 % of its capital structure.It will issue new equity and use the funds to retire existing debt.The interest rate on its debt is expected to remain at 3.6 %. a.What is Leveredâ Bank's expected ROE with 1.6 % âequity? b.Assuming perfect capitalâ markets, what will Leveredâ Bank'sexpected ROE be after it increases its equity to 3.2 %â? c.Consider the difference between Leveredâ Bank's ROE and its cost ofdebt. How does thisâ "premium" compare before and after theâ Bank'sincrease inâ leverage? d. Suppose the return on Leveredâ Bank'sassets has a volatility of 0.26 %. What is the volatility ofLeveredâ Bank's ROE before and after the increase inâ equity? e.Does the reduction in Leveredâ Bank's ROE after the increase inequity reduce its attractiveness toâ shareholders? Explain.
