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?

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.