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a. (5 marks). How many dollars of bad loans can each bank sustain before it becomes insolvent? As a result, which bank has the lower probability of becoming insolvent? b. (5 marks). Suppose net profit after taxes is $6 million for each bank. What is each bank's return on assets (ROA)? What is each bank's return on equity (ROE)? Which bank is more profitable to its owners? c. (5 marks). What does this example say about the relationship between safety and returns to equity holders? What is regulatory response to this situation? 5. (15 marks). Explain and show graphically the effect of an increase in the expected inflation rate on the equilibrium exchange rate, everything else held constant. 6. (Total: 10 marks). You are watching the news with a friend. The news anchor says that the Monetary Authority has just increased the interest rate. Your friend says, "I bet banks just love these increases in the interest rate. Banks must be making enormous profits charging those high interest rates. Bank stock prices must just be going through the roof." a. (5 marks). Use a description of gap analysis to explain to your friend how a rising interest rate tends to affect a bank's profits. b. (5 marks). Use a description of duration analysis to explain to your friend how a rising interest rate tends to affect a bank's net worth

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