Assets ($) Liabilities and Net Worth ($)
Reserves 20 Deposits 120
Bonds 10 Borrowings 40
Loans 230 Net Worth 100

The table above shows the balance sheet for a hypothetical bank. Call it Bank A. Interest rates increase and as a result bond prices change by 50 percent. This event causes the entries in the bank's balance sheet to change to the following:

Question

Assets ($)	Liabilities and Net Worth ($)
Reserves	20	Deposits	120
Bonds	10	Borrowings	40
Loans	230	Net Worth	100

The table above shows the balance sheet for a hypothetical bank. Call it Bank A. Interest rates increase and as a result bond prices change by 50 percent. This event causes the entries in the bank's balance sheet to change to the following:

BlackTom AI · Accepted Answer

We start by restating the given balance sheet scenario and the requested change. The initial balance sheet shows:
- Assets: Reserves 20, Bonds 10, Loans 230
- Liabilities & Net Worth: Deposits 120, Borrowings 40, Net Worth 100
The problem states that interest rates increase and bond prices change by 50 percent, which affects the value of the bank's bond holdings while other items remain unaffected.

Option-by-option analysis:
Option A: Deposits = 120 & Borrowings = 40 & Net Worth = 105 & Reserves = 20, & Bonds = 15 & Loans = 230
- This option keeps Deposits, Borrowings, Reserves, and Loans unchanged, which is plausible. However, it raises Net Worth to 105 and Bonds to 15, both inconsistent with the described 50% drop in bond prices. If bond prices fall, the market value of bonds should decrease, not rise. Therefore this option misstates the effect on bonds and net worth.

Option B (the second choice): Deposits = 120 & Borrowings = 40 & Net Worth = 95 & Reserves = 20, & Bonds = 5 & Loans = 230
- This option keeps the same balance sheet items except for Bonds and Net Worth: Bonds fall from 10 to 5, reflecting a 50% drop in bond value, and Net Worth falls from 100 to 95, indicating a realized or mark-to-market loss of 5 on the bond holdings. Since assets decrease by 5 (bonds from 10 to 5), and there are no other asset changes, the drop in Net Worth by 5 makes sense to balance the assets with liabilities. This aligns with the stated 50% price change in bonds and the implied reduction in equity.

Option C: Deposits = 120 & Borrowings = 35 & Net Worth = 100 & Reserves = 20, & Bonds = 5 & Loans = 230
- This option alters Borrowings downward from 40 to 35. There is no reason given in the scenario to change liabilities like borrowings when only bond prices change. Net Worth remains 100, which would require an offsetting asset increase to balance the accounting equation, but bonds are stated as 5 (a decrease), so the overall consistency is broken. Therefore this option is unlikely.

Option D: Deposits = 120 & Borrowings = 40 & Net Worth = 90 & Reserves = 15, & Bonds = 5 & Loans = 230
- Here, Reserves drop from 20 to 15 and Net Worth drops to 90, while Bonds drop to 5. The reserve change lacks justification from a pure bond price change scenario, and the reduction in Net Worth by 10 is larger than the observed 5 decline in bond value, unless reserves also absorb some loss. Since the given change emphasizes only the bond value change, this option introduces an extra, unsupported adjustment to reserves and equity.

Option E: None of the above
- Given that Option B provides a coherent accounting response to a 50% drop in bond prices with no other changes, this option is not necessary. However, it is still important to verify that there isn’t another option equally consistent. Since Option B fits the described mechanism and maintains internal consistency (bond value halved, net worth decreased by the same amount), selecting this as the correct change is reasonable.

Summary of the reasoning across options:
- The main driver is the 50% decrease in bond prices, which should reduce the asset value of Bonds by half and reduce Net Worth correspondingly if no other assets or liabilities are altered.
- Options that increase bond value or alter other balance-sheet items without justification are inconsistent with the described event.
- The most coherent adjustment is the one where Bonds drop from 10 to 5 and Net Worth declines by the same amount (from 100 to 95), with all other entries unchanged.

Thus, among the provided options, the set that reflects Bonds = 5 and Net Worth = 95 while keeping Deposits, Borrowings, Reserves, and Loans as in the original is the most consistent with a 50% price change in bonds affecting the bank’s equity accordingly.

ECN 001B C01-C06 WQ 2025 Final Examination (Winter 2025)

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