Q1. Forever Savings Bank estimates that building a new branch office in the newly developed Washington township will yield an annual expected return of 12 percent with an estimated standard deviation of 10 percent. The bank’s marketing department estimates that cash flows from the proposed Washington branch will be mildly positively correlated (with a correlation coefficient of + 0.15) with the bank’s other sources of cash flow. The expected annual return from the bank’s existing facilities and other assets is 10 percent with a standard deviation of 5 percent. The branch will represent just 20 percent of Lifetime’s total assets. Will the proposed branch increase Forever’s overall rate of return? Its overall risk? [1.5 Marks]
Q2. The following statistics and estimates were compiled by Big Moon Bank regarding a proposed new branch office and the bank itself:
Branch office expected return = 15%
Standard deviation of branch return = 8%
Existing bank’s expected return = 10%
Standard deviation of existing bank’s return = 5%
Branch asset value as a percentage of total bank assets = 16%
Correlation of net cash flows for branch and bank as a whole = +0.48
What will happen to Big Moon’s total expected return and overall risk if the proposed new branch project is adopted? [1.5 Marks]
Q 3. What do you think the Financial-Services industry will look like 20 years from now? What are the implications of your projections for its management today? [2 Marks- 500 words minimum]
Answer: