Suppose Bank One offers a risk-free interest rate of 4.5 % on both savings and loans and Bank Enn offers a risk-free interest rate of 5.0 % on both savings and loans. a. What arbitrage opportunity is available? b. Which bank would experience a surge in demand for loans? Which bank would receive a surge in deposits? c. What would you expect to happen to the interest rates the two banks are offering?

Question

Dominick Mendez

Business

9 February, 21:02

Suppose Bank One offers a risk-free interest rate of 4.5 % on both savings and loans and Bank Enn offers a risk-free interest rate of 5.0 % on both savings and loans. a. What arbitrage opportunity is available? b. Which bank would experience a surge in demand for loans? Which bank would receive a surge in deposits? c. What would you expect to happen to the interest rates the two banks are offering?

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Answers (1)

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Kian Owen · Answer 1

a) The opportunity of arbitrage is lending in Bank One, at 4.5%, and deposit the money in Bank Enn, at 5.0%.

b) Bank One

c) Bank Enn

d) The interest rates should become equal for both banks, for both loans and savings.

Explanation:

The opportunity of arbitrage is lending in Bank One, at 4.5%, and deposit the money in Bank Enn, at 5.0%. This would give a 0.5% return without investing any money of our own.

This would provoke a surge in demand for loans in Bank One and a surge in deposits in Bank Enn, for people executing the arbitrage opportunity.

The interest rates for loans and savings should tend to be equal between the two banks.