Problem 4: (15 Points) Bear Stears Bank's net income last year was $1,200m and its average net wealth (equity) was $15,000m. Average disclosed assets were $120,000m. 

a. If the risk-free rate is 1%, the market risk premium is 6% and Bear Stears Bank's exposure to market risk (equity beta) is 1.5, what was the bank's economic profit? What is the bank's ROE?

b. Now suppose that just prior to releasing financial statements, Bear Stears entered into a repo transaction that temporarily eliminated $40,000m in assets and debt from the balance sheet (i.e., the proceeds from the repo transaction are used to pay off debt). The transaction is undone immediately following the reporting date. What is the effect of this transaction on Bear Stears Bank's ROE? How may this transaction, which is unknown to the public, affect analysts' perception of Bear Stears Bank's performance?

c. Explain why it is possibly problematic to simply focus on ROE when comparing relative performance of financial intermediaries. Provide at least two examples supporting your arguments.

Answer rating: 100% (QA)

a Economic profitNet IncomeNet wealthCost of equity so calculating Cost of equity from the given det... View the full answer