Consider an FI that issues $100 million of liabilities with one year to maturity to finance the purchase of $100 million of assets with a two year maturity. Suppose that the cost of funds (liabilities) for the FI is 5 percent per year and the return on the assets is 8 percent per year.

a. Calculate the FI’s profit spread and dollar value of profit in year 1.

b. Calculate the profit spread and dollar value of profit in year 2, if the FI can refinance its liabilities at 5 percent.

c. If interest rates rise and the FI can borrow new one-year liabilities at 9 percent in the second year, calculate the FI’s profit spread and dollar value of profit in year 2

d. If interest rates fall and the FI can borrow new one-year liabilities at 3 percent in the second year, calculate the FI’s profit spread and dollar value of profit in year 2.