ASSIGNMENT CHAP 17 GROUP: WINDOW

Question:
7. The statement is true because in recent years, banks have to carry out 2 tasks raising funds and making loans instead of only making loans as before 1960s. Before 1960s, there was just 1 type of liability non-interest-bearing checking accounts (demand deposit) and hence depositors always remained loyal to a bank they usually traded with. Banks had difficulty to gain new depositors and they were less interested in liability management in return. Since 1960s, large banks in the US started to use liabilities to provide reserves and liquidity. This caused a rapid growth of overnight loans markets and more than ease for banks to get sufficient funds. Moreover, development of overnight loans markets increased borrowing between banks with a very high rate. Banks had more motive to set target goals for their asset growth and tied to acquire funds. As a result, liability management became more active and banking concerned more about raising funds besides making loans to expand their businesses. This means banking has become a more dynamic industry.

Quantitative Problem:
6. A bank with $100 million in demand deposits estimates that net daily deposits are, on average, $100 million with a standard deviation of $5 million. The bank wants to maintain a minimum of 8% of deposits in reserves as all times. What is the highest expected level of deposits during the month? What reserves do they need to maintain? Use a 99% confidence level. The highest that dem $5 million, or $115 million. To maintain 8% as reserves against this possibility, they must maintain 4115 M 0.08 A better approach would be to increase/decrease reserves as deposits are withdrawn, rather than maintain $9.2 million against the possibility of $115 M in deposits.

7. NewBank started its first day of operations with $6 million in capital. $100 million in checkable deposits is received. The bank issues a $25 million commercial loan and another $25 million in mortgages, with the following terms: Mortgages; 100 standard 30-year, fixed-rate with a nominal annual rate of 5.25% each for $250,000. Commercial loan: 3-year loan, simple interest paid monthly at 0.75%/month. If required reserves are 8%, what does the bank balance sheets look like? Ignore any loan loss reserves. Assets Required reserves Excess reserves Loans $ 8 million $48 million $50 million Liabilities Checkable deposits Bank capital $100 million $ 6 million

8. NewBank decides to invest $45 million in 30-day T-bills. The T-bills are currently trading at $4,986.70 (including commissions) for a $5,000 face value instrument. How many do they purchase? What does the balance sheet look like? The bank can purchase $45 M/$4,986.7, which is about 9,024 T-bills. The actual cost is $44,999,980.80 After the transaction, the balance sheet is: Assets Required reserves Excess reserves T-bills Loans $ 8 million $ 3 million $45 million $50 million Liabilities Checkable deposits $100 million Bank capital $6 million

9. On the 3rd day of operations, deposits fall by $5 million. What does the balance sheet look like? Are there any problems?

The cash leaving the bank comes from reserves, first excess and the required. Following the outflow, the balance sheet is: Assets Liabilities Required reserves $ 6 million Checkable deposits $95 million T-bills $45 million Bank capital $ 6 million Loans $50 million

10. To meet any shortfall in the previous question, NewBank will borrow the cash in the fed funds market. Management decides to borrow the needed funds for the remainder of the month (now 29 days). The required yield on a discount basis is 2.9%. What does the balance sheet look like after this transaction? The required reserves are 8% of $95 million, or 7.6 million. However, it just has 6 million in required reserves, so the bank has to borrow 1.6 million from the fed funds. Its balance sheet would then be: Assets Required reserves T-bills Loans $ 7.6 million $45 million $50 million Deposits Borrowing from the Fed Bank capital Liabilities $95 million $ 1.6 million $ 6 million

11. The end of the month finally arrives for NewBank, and it receives all the required payments from its mortgages, commercial loan, and T-bills. How much cash was received? How are these recorded? The required monthly mortgage payments are: LV = LV $25 million, i

+
5.25%, n 360, FV 0

Fixed monthly payment (FP) The loan payment is: $25 million $187,500 Total cash was received: $138,050.93 + $187,500 = $325,551 Debit Cash $325,551 Interest Income Loans Credit $296,875 $ 28,676

The T-bills paid:

Debit Credit $45,120,000 T-bills Interest Income $44,999,980.80 $ 120,019.20

Cash

12. NewBank also pays off its fed funds borrowed. How much cash is owed? How is this recorded? 0.029 = F = $1,603,746.53

Debit Fed Funds Interest Expense $1,600,000 $ 3,746.53 Cash

Credit $1,603,746.53

13. What does the month-end balance sheet for NewBank look like? Calculate this before any income tax consideration. Assets Required Reserves Excess Reserves Loans $ 7.6 million $43.84 million $49.97 million Liabilities Checkable Deposits $95 million Bank Capital $ 6.41 million

14. Calculate NewBanks ROA and NIM for its first month. Assume that net interest equals EBT, and that NewBank is in the 34% tax bracket. Interest income $416,894 Interest expense $ 3,747 Net Interest Margin (NIM) $413,147 Income tax $140,470 Net income $272,677 ROA = = = 0.002688 = 0.2688% (monthly)

15. Calculate NewBanks ROE and final balance sheet including its tax liabilities. Assets Required Reserves Excess Reserves Loans Liabilities Checkable Deposits $ 95 million Taxes Payable $140,470 million Bank Capital $ 6.27 million

$ 7.6 million $43.84 million $49.97 million

ROE =

= 0.0435 = 4.35% (monthly)

16. If NewBank was required to establish a loan loss reserve at 0.25% of the loan value for commercial loans, how is this recorded? Recalculate NewBanks ROE and final balance sheet including its tax liabilities. Debit loan loss expense (25M*0.25%) Credit loan loss reserve $62,500 $62,500

We have the new net income: Interest Income $416,894 Interest expense: $3,747 Loan loss expense $62,500 Taxable income: $350, 647 Income tax (34%*TI) $119,220 Net Income $231,427

The new balance sheet is: Asset Required reserves Excess reserves Loans Liabilities Checkable Deposits $95 Million Tax Payables $119,200 Loan loss reserve $62,500 Bank Capital $6.23 Million

$7.6 Million $43.84 Million $49.97 Million

The new bank s ROE = net income/equities = 231427/6228280 = 3.71%(monthly) 17. If NewBanks target ROE is 4.5%, how much net fee income must it generate to meet this target? The required net income = 4.5%*6Millions =270000 We get net income + income tax = taxable income 270000 + 34%*taxable income = taxable income New taxable income = 409091 Net fee income = new taxable income taxable income = 409091 350647 = 58444 18. After making payments for three years, one of the mortgage borrowers defaults on the mortgage. NewBank immediately takes possession of the house and sells it at auction for $175,000. Legal fees amount to $25,000. If no loan loss reserve was established for the mortgage loans, how is this event recorded? Present value: $2,500,000 Interest rate: 5.25% annual rate Number of payments: 360 Future value: 0 Use the software we have: monthly payment: $1,380.51

After 3 years: Interest rate: 5.25% annual rate Number of payments: 360-36 Month payments: $1,380.51 Future value: 0 So we have the remaining balance: $238,845.64 The transaction is Debit Cash $150,000 Loan Loan Loss Expense $88,845.64

Credit $238,845.64