Realizing that a financial intermediary's lending, treated as an investment opportunity, is like a financial call option clarifies the role of uncertainty. We argue that the portfolio-theoretic approach and the firm-theoretic approach have important linkages that can be used to demonstrate the contingent claim analysis of a rate-setting financial intermediary. Borrower-intermediary-lender relationships between the portfolio-theoretic combined volatilities and the firm-theoretic rate-setting modes under the Black-Scholes valuation are investigated, and the conclusions depend upon the portfolio composition redistribution effect. The effect of changes in the open market security rates on the loan rate and deposit rate settings depend on the borrower-intermediary-lender relationship, portfolio risk, and management of rate-setting strategy. Moreover, movements in open market security rates are not necessarily transmitted to the loan lender and deposit absorber.
International Review of Economics & Finance 9(4), pp.375-386