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Bank Management 8th edition Timothy W. Koch, S. Scott MacDonald - Solutions
What are the conceptual differences between the trend, seasonal, and cyclical components of a bank’s loans and deposits? Discuss why a bank should examine each component rather than simply look at total loans and deposits.
What are the advantages and disadvantages of using financial leverage? Answer from the banker’s point of view and then from the bank regulator’s point of view.
RBC requirements may induce bank managers to change their asset composition. Explain why. Determine how a shift from any of the following should affect a bank’s required capital. How will each shift affect the bank’s profit potential? a. From consumer loans to 1– 4 family mortgages b. From U.
A bank has decided it must raise external capital. Discuss the advantages and disadvantages of each of the following choices: a. Subordinated debt at 7.7 percent b. Preferred stock at a 10 percent dividend yield c. Common stock
What is the leverage capital ratio and why do regulators specify a minimum for it?
FDICIA imposes increasingly severe operating restrictions on undercapitalized banks (those in Zones 3, 4, and 5). Explain why these restrictions are appropriate. Describe how managers should respond to these restrictions if they manage an undercapitalized bank.
Some analysts believe that the new Basel III minimum capital requirements are excessive and will reduce bank profitability, ceteris paribus. Summarize these arguments.
What is the capital conservation buffer and what impact will it have on bank performance and risk?
Provide the general outline of existing RBC requirements. Is there a difference between default risk, interest rate risk, and liquidity risk?
Explain how capital reduces banking risks. Discuss the importance of cash flows and economic (market) value rather than accounting value.
Many analysts argue that RBC requirements should force banks to raise loan rates. Explain this by assuming that a bank’s management sets loan rates to earn a 16 percent ROE. How does the allocation of equity to a loan affect loan pricing?
Suppose that a bank wants to grow during the next year but does not want to issue any new external capital. Its current financial plan projects a ROA of 1.25 percent, a dividend payout rate of 35 percent, and equity to asset ratio of 8 percent. Calculate the allowable growth in the bank’s assets
Many regulators would like to see bank capital requirements raised. Consider a proposal to increase the minimum Tier 1 and total capital ratios to 9 percent and 12 percent, respectively. What impact would this have on bank risk? Would small banks and large banks have equal opportunity in meeting
Regulators put great pressure on banks to reduce their common dividend payments when asset problems appear. Discuss the costs and benefits of cutting dividends.
Two competing commercial banks situated in the same community have comparable asset portfolios, but one operates with a total capital ratio of 10 percent, while the other operates with a ratio of 12 percent. Compare the opportunities and risk profiles of the two banks.
Explain why increased regulatory capital requirements lead to a greater consolidation of banking firms via mergers and acquisitions.
Discuss the importance of a bank’s credit culture in managing credit risk.
Explain how banks move loans off the balance sheet. What motivates different types of off- balance sheet activities? Discuss the risks these actions involve.
What motivation encourages commercial banks to make variable rate mortgages? Why are variable rate mortgage rates normally below fixed mortgage rates? As the level of rates declines, would you expect banks to increase or decrease the adjustable rate proportion of their mortgage portfolios?
You are considering making a working capital loan to a company that manufactures and distributes fad items for convenience and department stores. The loan will be secured by the firm’s inventory and receivables. What risks are associated with this type of collateral? How would you minimize the
Discuss whether each of the following types of loans can be easily securitized. Explain why or why not. a. Residential mortgages b. Small business loans c. Pools of credit card loans d. Pools of home equity loans e. Loans to farmers for production
Describe the basic features of the following: a. Open credit lines b. Asset based loans c. Term commercial loans d. Short term real estate loans
Why do firms or individuals involved in farming need to borrow? What type of inventory does a farmer need?
What type of receivables does a farmer typically have? What collateral is typically available? In addition to general economic conditions, what should a banker be watchful of before extending credit to a farmer?
Many banks compete aggressively for business in consumer credit cards. What is the particular attraction of this type of lending?
Suppose that you are considering making a working capital loan to a business customer of your bank. You do the cash to cash cycle analysis and determine that the firm’s daily average cost of goods sold is $ 50,000. What does this mean?
Describe how each of the following helps a bank control its credit risk: a. Loan covenants b. Risk rating systems c. Position limits
Describe the basic features of the three functions underlying the credit process at commercial banks.
Describe what a ‘qualified mortgage’ is and explain the elements of the ability to repay rule.
What are the five Cs of credit? Discuss their importance in credit analysis. Describe the five Cs of bad credit introduced in the text.
Explain why historical charge off and past due data may not represent the bank’s current portfolio credit risk.
Explain why a large bank may be willing to accept higher average loss rates on loans it is able to credit score.
How does a bank make a profit on loans? Discuss the importance of loans in attracting a borrower’s other business with a financial institution.
Discuss reasons why banks might choose to include the following covenants in a loan agreement: a. Cash dividends cannot exceed 60 percent of pretax income. b. Interim financial statements must be provided monthly. c. Inventory turnover must be greater than five times annually. d. Capital
Explain what it means to “perfect the bank’s security interest” in collateral. When lending to a small business owner who is an owner/ manager, what methods might the bank use to perfect its interest in the collateral of the business?
Explain how a company’s permanent working capital needs differ from its seasonal working capital needs.
Rank the importance of the five basic credit issues described in the text.
Suppose that you generate a cash based income statement and determine that CFO equals 75 percent of cash dividends paid and payments on current maturities of long term debt. What is the significance of this in terms of the firm’s cash flow position?
Explain the importance of identifying the “primary” source of repayment. Clearly, the primary source of repayment is always “cash.” The analysis question is really one of identifying the source of the cash used to repay the loan. Explain the advantages and disadvantages of the following
Use the following data to calculate the requested ratios:* Prior- period inventory was 170. a. Current ratio b. Days accounts receivable c. Inventory turnover d. Days accounts payable outstanding e. Debt to equity f. Times interest earned g. ROE h. Total asset turnover (asset utilization)
Suppose that you have generated the estimates listed below from a pro forma analysis for a manufacturing company that had requested a three- year term loan. The loan is a $ 1.5 million term loan with equal annual principal payments. Principal and interest are payable at the end of each year with
Using the example in the text, develop a list of questions that a loan officer should ask Marcus Wade to gain a better understanding of the risks involved in lending to Wade’s Office Furniture.
Discuss why loan originators might consider selling a loan. Why might an institution consider buying loan participation? Why do large institutions participate in loan syndications? What are the advantages and disadvantages of serving as the lead bank?
Explain why collateral alone does not justify extending credit. Cite examples, using real estate or agricultural products as collateral.
Which of the following loan requests by an off campus pizza parlor would be unacceptable, and why? a. To buy cheese for inventory b. To buy a pizza heating oven c. To buy a car for the owner d. To repay the original long term mortgage used to buy the pizza ovens e. To pay employees due to a
Of the five key questions mentioned at the beginning of the chapter, only the last four were discussed in detail. The first question—“ What is the character of the borrower and quality of information provided?”— can be the most important. Explain why this is the first question the lender
Explain how the following situations can shed light on the question, “What is the character of the borrower and quality of information provided?” Significant number of Better Business Bureau complaints. The business is a family business and several members of the family work for the business.
Standard ratio analysis distinguishes between four categories of ratios. Describe how ratios in each category indicate strength or weakness in the underlying firm’s performance.
Generally, a high current ratio is an indicator of good liquidity. Under what circum-stances or conditions could a high current ratio be an indicator of problems with the company’s current assets?
Explain how it is possible for a firm to report rising NI each year yet continue to need more working capital financing from a bank.
Indicate whether each of the following is a source of cash, use of cash, or has no cash impact. a. Firm issues new long term debt. b. Firm prepays operating costs. c. Because the firm buys another firm, it amortizes goodwill. d. Firm sells outdated computer equipment. e. Firm pays a stock
Explain how an installment loan differs from revolving credit in terms of risk and the nature of the return to the lender.
The differential between fixed- rate credit card rates and a bank’s cost of funds typically varies over the interest rate cycle. What is this relationship, and why does it exist? Does the differential between commercial loan rates and a bank’s cost of funds behave similarly?
Calculate the effective annual rate on each of the following loans: a. A $ 5,000 loan for two years, 10 percent simple annual interest, with principal repayment at the end of the second year b. A $ 5,000 loan for two years, 10 percent add on interest, paid in 24 equal monthly installments c. A $
What is the purpose of a dealer reserve in indirect lending? When is a bank at risk with indirect loans?
What is the goal of the CRA? How do regulators enforce its provisions?
Subprime loans have higher loss rates than many other types of loans. Explain why lenders offer subprime loans. Describe the characteristics of the typical borrower in a subprime consumer loan.
Explain generally how smart cards, debit cards, and prepaid cards differ from traditional credit cards.
What are the major expenses associated with making consumer loans? What is the average size of consumer installment loans at small banks? How does loan size affect loan rates that banks charge on consumer loans?
Examine the credit card loss rates and personal bankruptcy filings in Exhibit 15.4. What might explain the increase in both measures after 1994 in a period when economic growth in the United States was strong and unemployment was low? Given the problems in 2008– 2009, what will be the likely
Why are home equity loans attractive today? How do some banks tie home equity loans to a customer’s credit card? How did the credit crisis and subprime problems of 2008– 2009 change the attractiveness of home equity loans? How might this change in the future?
Explain how a direct installment loan differs from an indirect installment loan.
What are the key provisions of the ECOA? Why was such legislation necessary?
Describe how a bank should apply an objective credit scoring model when evaluating consumer loan requests. Given the information in Exhibits 15.10 and 15.11 and in the text, indicate why you would or would not approve Rochelle Groome’s loan request.
Suppose that four college students check their FICO scores and discover the information listed below. Describe how lenders might price loans to the borrowers with lower scores versus the borrowers with higher scores in terms of rates and fees charged. Score Vanessa 790 Martin 550 Jorge
What different sources of revenue are available from credit card lending? Outline the clearing process with a credit card transaction. What is the biggest risk in credit card loans?
FASB 115 requires certain classifications within a bank’s securities portfolio. What is the accounting treatment of securities within each classification? Describe why full market- value accounting might adversely affect a bank’s reported capital. How should management classify the bank’s
Explain what impact accumulated other comprehensive income (from unrealized securities gains or losses) has on bank regulatory capital.
Discuss the impact of each of the following on prepayment risk for a mortgage backed pass through security (MBS): a. High coupon interest MBS versus low coupon interest MBS b. MBS issued six years prior versus MBS issued this year c. Demographic trends in different areas of the country
Explain how the design of a CMO supposedly helps to manage prepayment risk for investors. What is a tranche?
Suppose that you own a four year maturity Treasury bond that pays $ 100,000 in principal at maturity and $ 3,000 every six months in coupon interest. Use the features of the bond to explain what Treasury IOs and POs are.
Consider a $ 100 million pool of conventional mortgages paying 8 percent interest. Suppose that you create one PO and one IO for this entire pool. Describe what a PO and IO would look like for this mortgage pool.
Large banks often borrow heavily in the federal funds market and maintain small investment portfolios relative to their asset size. Are these offsetting risk positions? Why do large banks organize themselves this way?
Describe the characteristics of the ladder investment strategy and compare them to the barbell investment strategy. Why should the barbell strategy outperform the ladder strategy in a stable or declining interest rate environment? Why should the ladder strategy outperform the barbell strategy in a
The term- structure of U. S. Treasury interest rates generally exhibits certain shapes during different stages of the business cycle. Discuss this relationship and explain why it holds, on average. What shape does the yield curve take prior to a recession in the United States?
What rationale suggests that a contra cyclical investment strategy should, on average, outperform the market? Is it possible to consistently earn above- average returns by timing security purchases?
Explain why bank managers often refuse to sell securities at a loss relative to book value. What is the cost of continuing to hold discount instruments? What are the costs of selling securities at a gain?
Suppose that the U. S. Treasury yield curve is continuously downward- sloping. To maximize interest income over the next 10 years, should a bank portfolio manager buy securities with maturities of under 1 year or securities with maturities of 10 years? Explain what factors should be used to make a
Provide one reason for using the bank’s investment portfolio to speculate on interest rate movements. Provide one reason against such a strategy. What do you believe about efficient markets, and how does this influence your opinion of speculating? Can investors accurately forecast the direction
Suppose that a bank’s ALCO reports that the bank is too liability sensitive; that is, earnings will fall more than desired should rates rise. You have been asked to reduce the bank’s earnings sensitivity. What specific strategies might the investment man-ager pursue? Identify the cost and
Describe the basic strategy in riding the yield curve. Can you ride the yield curve if the yield curve is downward sloping with short- term rates above long- term rates?
In each of the following cases, identify the buyer and seller of the option, how the value of the option is indicated, and when (in what interest rate environment) the option will be exercised: a. A bank buys a five year maturity GNMA bond that is callable at par after one year, yielding 6.88
Suppose that you own a callable U. S. agency bond like that in Exhibit 16.9. Explain why your total return will fall when interest rates rise. Identify changes in return associated with each component of total return. Why will total return rise when rates fall?
Suppose that a bank currently owns a $ 5 million par value Treasury bond, purchased at par, with four years remaining to maturity that pays $ 200,000 in interest every six months. Its current market value is $ 5.23 million. If the bank sold the bond and reinvested the proceeds in a similar
Suppose that the above bank also owns a $ 1 million par value Treasury bond, purchased at par, with two years to maturity, paying $ 29,000 in semiannual interest, with a market value of $ 960,000. Determine the incremental cash flow effects if the bank sold this note and bought a two year taxable
You pay federal income taxes at a 28 percent marginal tax rate. You have the choice of buying either a taxable corporate bond paying 7.10 percent coupon interest or a similar maturity and risk municipal bond paying 5.90 percent coupon interest. a. Which bond offers the higher after tax yield? b.
What types of securities are banks prohibited from buying for investment purposes?
Explain how the composition of a small community bank’s investment portfolio differs, in general, from the composition of a large bank’s portfolio. Why might mutual funds be attractive to banks?
How did the provisions of Section 939A of the Dodd– Frank Act alter the behavior of banks in managing their investment portfolios?
What is the option in a callable agency bond? What impact does the call deferment period have on a callable bond’s promised yield? What is the primary advantage of a discount callable bond versus one trading at par?
List the objectives that banks have for buying securities. Explain the motive for each.
What key attributes of a security make it a suitable investment for a bank?
Discuss the differences between Eurocurrency, Eurobonds, and Eurocredits.
Assume that the forward exchange rate is for 90 days forward and the interest rates are annualized 90- day rates in Question 9. Can a trader earn covered interest arbitrage profits?
Suppose that Commerce Bank in Poland holds $ 400 in assets and $ 1,000 in liabilities denominated in dollars. The home currency is the zloty, and the current spot exchange rate is $ 1 = 145 zlotys. a. What is the bank’s net exposure in dollars? b. Will the bank gain or lose if the spot
Why were IBFs created? How do they differ from Edge Act and Agreement corporations?
Explain how you would measure country risk in international lending. Can you get a precise statistical measure?
The U. S. system of banking historically led to many more banks that were smaller in size and operated with few branches. Why did the U. S. banking system develop so differently from that of other countries? What factors have brought about a change in the U. S. system that makes it look more like
Identify several large foreign institutions that are major lenders in the United States. Do any have a basic competitive advantage over U. S. commercial banks? Explain.
Which of the following types of foreign banking operations would best suit the circumstance described? a. A major customer of a U. S. commercial bank requests a loan to finance growing export activity in Mexico. b. Management notices that an increasing number of its business customers have
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