A bank has $125 million in three (3) year loans earning a fixed rate equal to 6.5%. The assets are funded by $125 million in liabilities that have a cost of 4.5% and a maturity of 1 year. If interest rates are projected to fall 100 basis points by next year, by how much will the bank’s profits and NIM change in year 2? Does this bank face refinancing risk or reinvestment risk?Explain.
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