Off-balance-sheet

Chapter 9Exercise:Ⅰ.Key terms1. discount loan2. capital adequancy management3. interest-rate risk4. discount rate5. ROA6. EM7. ROE8. Compensating balance9. Gap analysis 10. Off-balance-sheet activitiesⅡ. Multiple Choice：1. A bank’s balance sheeta. shows that total assets equals total liabilities plus equity capital.b. lists sources and uses of bank funds.c. indicates whether or not the bank is profitable.d. does all of the above.e. does only (a) and (b) of the above.2. Which of the following are reported as liabilities on a bank’s balance sheet?a. Reservesb. Small denomination time depositsc. Loansd. Deposits with other banks3. Checkable deposits and money market deposit accounts area. payable on demand.b. liabilities of the banks.c. assets of the banks.d. only (a) and (b) of the above.e. only (a) and (c) of the above.4. Large-denomination CDs are _____, so that like a bond they can be resold in a _____ market before they mature.a. nonnegotiable; secondaryb. nonnegotiable; primaryc. negotiable; secondaryd. negotiable; primary5. Banks acquire funds from such sources asa. bank capital.b. cash items in the process of collection.c. reserves.d. only (a) and (b) of the above.6. Bank reserves includea. deposits at the Fed.b. vault cash.c. short-term Treasury securities.d. all of the above.e. both (a) and (b) of the above.7. Which of the following are not reported as assets on a bank’s balance sheet?a. Cash items in the process of collectionb. Deposits with other banksc. U.S. Treasury securitiesd. Checkable deposits8. Of the following bank assets, the most liquid isa. consumer loans.b. state and local government securities.c. physical capital.d. U.S. government securities.e. commercial loans.9. In general, banks make profits by selling _____ liabilities and buying _____ assets.a. long-term; shorter-termb. short-term; longer-termc. illiquid; liquidd. risky; risk-free10. When you deposit $50 in your account at First National Bank and a $100 check you have written on this account is cashed at Chemical Bank, thena. the liabilities of First National decrease by $50.b. the reserves at First National increase by $50.c. the liabilities at Chemical Bank increase by $50.d. only (a) and (b) of the above occur.11. When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the bank’s final balance sheet,a. the assets at the bank increase by $800,000.b. the liabilities of the bank increase by $1,000,000.c. the liabilities of the bank increase by $800,000.d. reserves increase by $160,000.12. If a bank has $100,000 of deposits, a required reserve ratio of 20 percent, and it holds $30,000 in reserves, and then it has enough reserves to support a deposit outflow ofa. $20,000.b. $11,000.c. $5,000.d. either (a) or (b) of the above.e. either (b) or (c) of the above.13. Banks protect themselves from the disruption of deposit outflows bya. holding excess reserves.b. selling securities.c. “calling in” loans.d. doing all of the above.e. doing only (a) and (b) of the above.14. A bank holding insufficient reserves can meet its reserve requirements bya. borrowing federal funds.b. borrowing from other banks.c. selling secondary reserves.d. all of the above.e. both (a) and (b) of the above.15. One way for a bank to assure depositors that it is not taking on too much risk, and so obtain their deposits, is for it toa. diversify its loan portfolio.b. reduce its equity capital.c. lengthen the maturity of its assets.d. shorten the maturity of its liabilities.16. Compensating balancesa. are a particular form of collateral commonly required on commercial loans.b. are a required minimum amount of funds that a borrower (i.e., a firm receiving a loan) mustc. keep in a checking account at the bank.d. allow banks to monitor firms’ check payment practices which can yield information about their borrowers’ financial conditions.e. all of the above.17. Credit rationing occurs when a banka. refuses to make a loan of any amount to a borrower, even when she is willing to pay a higher interest rate.b. restricts the size of the loan to less than the borrower would like.c. does either (a) or (b) of the above.d. does neither (a) nor (b) of the above.18. Credit risk management tools include:a. compensating balances.b. collateral.c. restrictive covenants.d. all of the above.e. only (a) and (b) of the above.19. Examples of off-balance–sheet activities includea. loan sales.b. foreign exchange market transactions.c. trading in financial futures.d. all of the above.e. eonly (a) and (b) of the above.20. Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of liabilities with a duration of 1.05. The duration gap for this bank isa. 0.5 year.b. 1 year.c. 1.5 years.d. 2 years.e. 2.4 years.Ⅲ. Calculation1.Assets LiabilitiesRate-sensitive $20 million $50 millionFixed-rate $80 million $50 million(a)If interest rates rise by 5 percentage points, say, from 10 to 15%, bank profits (measured using gap analysis) will how to change?(b)Assuming that the average duration of its assets is five years, while the average duration of its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National how to change?2. Suppose that you are the manager of a bank whose $100 billion of assets have an average duration of four years and whose $90 billion of liabilities have a n averageduration of six years. Conduct a duration analysis for the bank, and show what will happen to the net worth of the bank if interest rate by 2%?Ⅳ. Analyzing and explanation1．What happens to reserves at first National Bank if one person withdraws $1000 of cash and another person deposits $500 of cash? Use T-account to explain your answer.2．Assume a customer deposits $1000 in her bank. Show in a T-account the effect of this deposit. If the bank is subject to reserve requirements, show in a second T-account the banks balance sheet indicating required and excess reserve. In a third T-account, show the change in the bank’s balance sheet when the bank makes loans with the excess reserves.3．Rank the following bank assets from most to least liquid: a. Commercial b.Securities c.Reserve d.Physical capital.4．Explain the general principle of bank management.5．A bank almost always insists that the firms it lends to keep compensating balances at the bank, why?Ⅴ. Compiling and analyzing1. Assume the following balance sheet for the First National Bank:the effect of a 3 percent decrease in rates? Why is knowledge of interest-rate risk important? How might banks respond if rates are expected to change unfavorably?2. Explain the relationship between return on assets and return on equity. What incentives does this relationship give a bank manager? Is this the desired outcome preferred by regulators? Discuss.Answer:Ⅰ. Key terms1. A bank’s borrowings from the Federal Reserve System; also know as advanc e.2. A bank’s decision about the amount of capital it should maintain and then acquisition of needed capital.3. The possible reduction in returns associated with changes in interest rate.4. The interest rate that the Federal Reserve charges banks on discount loan.5. Net profit after taxes per dollar of asset.6. The amount of assets per dollar of equity capital.7. Net profit after taxes per dollar of equity capital.8. A required minimum amount of funds is that a firm receiving a loan must keep in a checking account at the lending bank.9. A measurement of the sensitivity of bank profit to changes in interest rates, calculated by subtracting the amount of rate-sensitive liabilities from the amount of rate-sensitive assets.10. Bank activities that involve trading financial instruments and the generation of income from fees and loan sales, all of which affect bank profit but are not visible on bank balance sheetsⅡ. Multiple Choice：1 e2 b3 d4 c5 a6 e7 d8 d9 b 10 a 11 b 12 e13 d 14 d 15 a 16 d 17 c 18 d 19 d 20 cⅢ. calculation1. Answer:(a) decline by $1.5 million.(= $20 million×5%－$50 million×5%)(b) decline by $10 million.(= $100 million×5%×5 years－$100 million×5%×3 years)2. Answer: The assets fall in value by $8million(=$100 million×－2%×4 years ) while the liabilities fall in value by $10.8 million(=$90 million×－2%×6 years).Since the liabilities fall in value by $2.8 million more than the assets do, the net worth of the bank rises by $2.8 million.Ⅳ. Analyzing and explanation1. Answer: Reserve drop by $500.The T-account for the First National Bank is as follows:First National BankLoans$9003. Answer: The rank from most to least liquid is (c),(b),(a),(d)4. Answer: The first is to make sure that the bank has enough ready cash to pay its depositors when there are deposit outflow, the bank must engage in liquidity management. Second, the bank manager must pursue an acceptably low level of risk by acquiring assets that have a low rate of default and by diversifying asset holding (asset management).The third concern is to acquire funds at low cost(liability management).5. Answer: Compensating balance can act as collateral. They also help establish long-term customer relation-ships, which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem. Compensating balances help the bank monitor the activities of a borrowing firm so that it can prevent the firm from taking on too much risk, thereby not acting in the interest of the bank.Ⅴ. Compiling and analyzing1. Answer: The gap is –$40 million. A 4 percent rate increase reduces profits by $1.6 million, while a 3 percent rate decrease increases profits by $1.2 million. Obviously, knowledge of interest-rate risk is important for understanding the impact of interest rate changes on bank profits. If an adverse change in interest rates is expect, banks can change their assets and liability mix to reduce or eliminate unfavorable gaps.2. Answer: For a given return on assets, the greater the amount of capital, the lower is the return on equity. Bank managers who seek to increase the return on equity must increase the asset base, purchase riskier assets, or reduce the amount of capital by paying dividends or buying back stock.Regulators (and depositors) prefer higher capital for bank safety. Managers typically prefer lower equity than regulators, resulting in regulatory bank capital requirements.。