THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 376

344 PA R T I V The Management of Financial Institutions QUESTIONS You will find the answers to the questions marked with an asterisk in the Textbook Resources section of your MyEconLab Why might a bank be willing to borrow funds from the Bank of Canada at a higher rate than it can borrow from other banks? *2 Rank the following bank assets from most to least liquid: a Commercial loans b Securities c Reserves d Physical capital Why has the development of overnight loan markets made it more likely that banks will hold fewer reserves? *4 If the bank you own has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the customer down, explaining that you don t have any excess reserves to lend out? Why or why not? What options are available for you to provide the funds your customer needs? If a bank finds that its ROE is too low because it has too much bank capital, what can it to raise its ROE ? *6 If a bank is falling short of meeting its capital requirements by $1 million, what three things can it to rectify the situation? If a bank doubles the amount of its capital and ROA stays constant, what will happen to ROE ? *8 What does the net interest margin measure, and why is it important to bank managers? Which components of operating expenses experience the greatest fluctuations? Why? 10 Can a financial institution keep borrowers from engaging in risky activities if there are no restrictive covenants written into the loan agreement? *11 Why are secured loans an important method of lending for financial institutions? 12 If more customers want to borrow funds at the prevailing interest rate, a financial institution can increase its profits by raising interest rates on its loans Is this statement true, false, or uncertain? Explain your answer *13 Why is being nosy a desirable trait for a banker? 14 A bank almost always insists that the firms it lends to keep compensating balances at the bank Why? *15 Because diversification is a desirable strategy for avoiding risk, it never makes sense for a financial institution to specialize in making specific types of loans Is this statement true, false, or uncertain? Explain your answer Q U A N T I TAT I V E P R O B L E M S Using the T-accounts of the First Bank and the Second Bank, describe what happens when Jane Brown writes a $50 cheque on her account at the First Bank to pay her friend Joe Green, who in turn deposits the cheque in his account at the Second Bank *2 What happens to reserves at the First Bank if one person withdraws $1000 of cash and another person deposits $500 of cash? Use T-accounts to explain your answer The bank you own has the following balance sheet: Assets Reserves $ 75 million Loans $525 million Liabilities Deposits $500 million Bank capital $100 million If the bank suffers a deposit outflow of $50 million and has a desired reserve ratio on deposits of 10%, what actions must you take to keep your bank from failing? *4 If a deposit outflow of $50 million occurs, which balance sheet would a bank rather have initially, the balance sheet in Problem or the following balance sheet? Why? Assets Reserves $100 million Loans $500 million Liabilities Deposits $500 million Bank capital $100 million For Problems 9, assume that the First Bank initially has the balance sheet shown on page 334 Also assume that the average duration of its assets is three years, that of its liabilities is two years, that interest rates are initially at 10%, and that the bank s equity capital is $10 million If the First Bank sells $10 million of its fixed-rate assets and replaces them with rate-sensitive assets, what is the income gap for the bank? What will happen to profits next year if interest rates fall by percentage points?