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CFA Level I · CFA Level I Exam · Analyzing Balance Sheets

An analyst compares two otherwise identical banks. Bank X classifies its bond portfolio as measured at amortized cost, and Bank Y classifies the same bonds as fair value through other comprehensive income. Market interest rates rise sharply. Relative to Bank Y, Bank X's reported equity is most likely:

Bank X's equity is most likely higher. Bonds at amortized cost are not marked to market, so unrealized losses from rising rates are not recognized. Bank Y reports fair value and records the decline in other comprehensive income, which reduces its equity.

  1. Ahigher, because unrealized losses are not recognized in its balance sheetCorrect
  2. Blower, because amortized cost bonds are written down to market value
  3. Cthe same, because both classifications use fair value on the balance sheet

Explanation

When rates rise, bond fair values fall. Bank Y carries the bonds at fair value and recognizes the decline in OCI, reducing equity. Bank X carries them at amortized cost, so the unrealized loss does not appear and equity is higher. The other options wrongly assume fair value for both or a write-down for X.

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