ABC Bank does business with an XYZ investment company, whose only business is to buy long-term loans from ABC Bank. XYZ borrows on a short-term basis from investors to buy the loans and profits by earning a spread on the long-term loans and short-term borrowing.
a) Suppose that a financial crisis happens and XYZ’s lenders become concerned about its assets. They refuse to renew their lending to XYZ and XYZ calls ABC for support. What should ABC consider in making this decision?
b) Suppose instead there is no financial crisis and XYZ is able to renew its borrowing on market terms. What else could go wrong for XYZ?