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Economics 2154A/B Study Guide - Chemical Bank, Moral Hazard, Yield Curve

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School
Western University
Department
Economics
Course
Economics 2154A/B
Professor
Desmond Mc Keon

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Document Summary

Chapter 13 banking and the management of financial institutions. 13. 1 the bank balance sheet: which of the following statements are true, a bank"s assets are its sources of funds. ________ and its liabilities ________: increase; increase b) increase; decrease c) decrease; increase d) decrease; decrease, when jane brown writes a cheque to her nephew (who lives in another province), ms. ,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is ________. A) ,000 b) ,000 c) ,000 d) ,000: if a bank has ,000 of demand deposits, a desired reserve ratio of 20 percent, and it holds. ,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is ________. ________: shave credit b) rediscount the loan c) raze credit d) ration credit, credit risk management tools include ________, deductibles b) collateral c) interest rate swaps d) duration analysis.

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Related Questions

Leverage

Consider the following balance sheets of two banks. These two banks have equal amounts of assets but are leveraged differently. Assume that there is no regulatory capital requirement.

Balance Sheet of Arch Bank
Assets Liabilities and Net Worth
Outstanding Loans $100,000 Deposits (Liabilities) $80,000
    Capital (Net worth) 20,000
Total $100,000 Total $100,000
Balance Sheet of Medes Bank
Assets Liabilities and Net Worth
Outstanding Loans $100,000 Deposits (Liabilities) $95,000
    Capital (Net worth) 5,000
Total $100,000 Total $100,000

a. Which bank has a lower leverage ratio?

b. Suppose both banks' assets increase by 10% to $110,000. Assume that the liabilities of both banks remain the same. Arch Bank's capital increases by _____% and Medes Bank's capital increases by _______%. Therefore, if the value of assets is rising and liabilities do not change, a higher leverage ratio results in a _____ percentage increase in capital.

c. Now suppose all the items on the balance sheets of both banks return to their initial values. Suddenly, the banks realize that loans they made are riskier than they thought, and the total value of their assets declines by 5% to $95,000. Again, assume that the liabilities of both banks remain the same. Arch Bank's capital decreases by __________%, and Medes Bank's capital decreases by ______%. Therefore, if the value of assets is falling, a higher leverage ratio means a ________ percentage decrease in capital.

d. Under this second scenario, which bank is closer to insolvency?

Q2/PG.288 – Suppose a bank’s balance sheet looks as follows:
Assets Liabilities
Reserves $450 Deposits $5,000
and banks are required to hold reserves equal to 10% ofdeposits.
(a) How much excess reserve does the bank hold?
Answer: $4,500
(b) How much more can this bank lend?
Answer: $4,500
Q6/PG.288 – (a) When the reserve requirement changes, which of thefollowing will change for an individual bank (answer “change or “nochange”).
Transaction deposits - No Change
Total reserves - Change
Required reserves - Change
Excess reserves - Change
Lending capacity - Change
(b) When the reserve requirements changes, which of the followingwill change in the total banking system?
Transaction deposits - Change
Total reserves - No Change
Required reserves - No Change
Excess reserves - No Change
Lending capacity - Change
Q8/PG.288 – Suppose that a lottery winner deposits $20 million incash into her transactions account at the Bank of America. Assume areserve requirement of 25% and no excess reserves in the bankingsystem prior to this deposit.
(a) Use step 1 in the T-accounts below to show how her depositaffects the balance sheet
at B of A.
(b) Has the money supply been changed by her deposit? Answer:No
(c) Use step 2 below to show the changes at B of A after the bankfully uses its new lending
capacity.
(d) Has the money supply been changed in step 2? Answer: Yes
(e) In step 3 the new borrower(s) writes a check for the amount ofthe loan in step 2. That
check is deposited at another bank, and B of A pays the other bankwhen the check clears.
What does the B of A balance sheet look like now?
( f ) After the entire banking system uses the lending capacity ofthe initial ($20 million) deposit,
by how much will the following have changed?
Total reserves = 8,750,000
Total deposits = 20,000,000
Total loans = 15,000,000
Cash held by public = 20,000,000
The money supply = 35,000,000
Step 1: Winnings Deposited
Bank of America
_____________________________________________________________________________________
Assets Liabilities
(in millions) (in millions)
_____________________________________________________________________________________
Reserves = 20,000,000 Deposits = 20,000,000
Required = 5,000,000
Excess = 15,000,000
Subtotal = 20,000,000
Loans =
Total assets = 20,000,000 Total liabilities = 20,000,000

Step 2: Loans Made
Bank of America
Assets Liabilities
(in millions) (in millions)
Reserves = 20,000,000 Deposits = 20,000,000
Required = 8,750,000
Excess = 11,250,000
Subtotal = 40,000,000
Loans = 15,000,000
Total Assets = 35,000,000 Total Liabilities = 35,000,000


Step 3: Check Clears
Bank of America
Assets Liabilities
(in millions) (in millions)
Reserves = 20,000,000 Deposits = 20,000,000
Required = 5,000,000
Excess = 15,000,000
Subtotal = 20,000,000
Loans =
Total Assets = 20,000,000 Total Liabilities = 20,000,000

1. Explain the basic functions and the characteristics of financial market

2. What are the three functions of money?

3. What is the future value of a $100 deposit earning interest at 7% for the next two years?

4. Explain the effect on the future value when interest rate increases (or decreases)

5. Distinguish the difference between real and nominal interest rates.

6. What factors will shift the demand of bonds?

7. What factors will shift the supply of bonds?

8. What items are reported as assets for a bank? What items are reported as liabilities for a bank?

9. If a bank has $400,000 of checkable deposits, a required reserve ratio of 20%, and it holds $160,000 in reserves, then the maximum deposit outflow it can sustain is?

10. Explain the following terms:

a. Adverse selection

b. Moral hazard

11. What are off-balance-sheet activities of a bank?

12. What is the contagion effect?

13. Explain why banks engage in financial engineering?

14. What the functions of Federal Reserve?

15. Explain why the Federal Reserve is independent?