Question one: What happens to the value of equity when the value of mortgages decline?
Under the scenario where the price of mortgages decrease, financial institutions such as banks will reduce their investments as well as the lending. Therefore, consumers will experience some difficulties while obtaining home equity loans. For instance, the withdrawal of capital in the United Kingdom put up extra pounds into the economy before the financial crisis. Thus, leading to negative pounds in 2008 (Investopedia). The declining value for mortgages have an adverse effects on the banking industry. It implies that falling mortgages will make financial institutions to lose cash especially when bank’s clients default from their mortgage payments. Consequently, the losses will lead to low lending and investment or capital (Pettinger).
Question two
When the value of equity that pays 4% increases and additional liabilities are used to buy loans that pay 6%, the value of equity will increase, and the value of the long-term assets will fall by more the short term liabilities. If the rate of the equity is expected to decline, the manager needs to reverse the strategies of the bank. This will involve changing the mix of assets and liabilities. However, the attempts of making the changes may affect some changes in financial strategies of the bank, and this may not be easy to achieve.
Question three
The scenario will lead to a deficit net worth because liabilities will be more than the assets. The negative net worth always occurs when the current or future value of assets are eroding unexpectedly. For example, when the prices of homes decrease, one will be left owing more on their mortgage than the value of the home at present. However, a deficit net worth does not imply that the bank is bankrupt because just as the value of assets can quickly plunge, it can also rise. On the other hand, such negative net worth can affect the future financing opportunities and business growth.
Works Cited
"How Does A Decline In Housing Prices Affect The Banking Sector? | Investopedia". Investopedia. N.p., 2015. Web. 4 Aug. 2016. <http://www.investopedia.com/ask/answers/032315/how-does-decline-housing-prices-affect-banking-sector.asp>.
Pettinger, Tejvan. "Impact Of Falling House Prices | Economics Help". Economicshelp.org. N.p., 2008. Web. 4 Aug. 2016. <http://www.economicshelp.org/blog/1032/housing/why-falling-house-prices-cause-a-recession/>.
