Financial Institutions Management 8th Edition Anthony Saunders, Marcia Cornett - Solutions

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1. AllStarBank has the following balance sheet (in millions): Assets Liabilities and Equity Cash $ 30 Deposits $110 Loans 90 Borrowed funds 40 Securities 50 Equity 20 Total assets $170 Total liabilities and equity $170 AllStarBank’s largest customer decides to exercise a $15 million loan
1. A DI with the following balance sheet (in millions) expects a net deposit drain of $15 million. Assets Liabilities and Equity Cash $10 Deposits $68 Loans 50 Equity 7 Securities 15 Total assets $75 Total liabilities and equity $75 Show the DI’s balance sheet if the following conditions occur:
1. What are two ways a DI can offset the effects of asset-side liquidity risk such as the drawing down of a loan commitment?
1. How do the two methods differ? What are the operational benefits and costs of each method?
1. What are two ways a DI can offset the liquidity effects of a net deposit drain of funds?
1. How is a DI’s distribution pattern of net deposit drains affected by the following? The holiday season. Summer vacations. A severe economic recession. Double-digit inflation.
1. The probability distribution of the net deposit drain of a DI has been estimated to have a mean of 2 percent and a standard deviation of 1 percent. Is this DI increasing or decreasing in size? Explain.
1. What role do core deposits play in predicting the probability distribution of net deposit drains?
1. What are core deposits?
1. What are the two reasons liquidity risk arises? How does liquidity risk arising from the liability side of the balance sheet differ from liquidity risk arising from the asset side of the balance sheet? What is meant by fire-sale prices?
1. How does the degree of liquidity risk differ for different types of financial institutions?
1. How do the incentives of mutual fund investors to engage in runs compare with the incentives of DI depositors?
1. What would be the impact on their liquidity needs if DIs offered deposit contracts of an open-end mutual fund type rather than the traditional all-or-nothing demand deposit contract?
1. Is the liquidity risk of property–casualty insurers in general greater or less than that of life insurers?
1. What is the greatest cause of liquidity exposure faced by property–casualty insurers?
1. Can a life insurance company be subjected to a run? If so, why?
1. What is likely to be a life insurance company’s first source of liquidity when premium income is insufficient?
1. What are the two major uses? What are the five measures of liquidity risk used by FIs?
1. What are the three major sources of DI liquidity?
1. List two benefits and two costs of using (a) purchased liquidity management and (b) stored liquidity management to meet a deposit drain.
1. Why is cash more liquid than loans for an FI?
1. What are the sources of liquidity risk?
Go to the Standard & Poor's Market Insight Web site at www.mhhe.com/ edumarketinsight. Use the following steps to identify the Industry Financial Highlights for the following industries: Diversified Banks, Investment Banking & Brokerage, Life & Health Insurance, and Property & Casualty Insurance.
Go to the Standard & Poor's Market Insight Web site at www.mhhe.com/ edumarketinsight. Use the following steps to identify the Industry Description and Industry Constituents for the following industries: Diversified Banks, Investment Banking & Brokerage, Life & Health Insurance, and Property &
Go to the Federal Reserve Board's Web site at www.federalreserve.gov. Find the latest figures for financial assets outstanding at various types of finan- cial institutions using the following steps. Click on "Economic Research and Data." Click on "Statistics: Releases and Historical Data." Click on
Go to the Federal Reserve Board's Web site at www.federalreserve.gov. Find the latest figures for M1 and M2 using the following steps. Click on "Economic Research and Data." Click on "Statistics: Releases and Historical Data." Click on "Money Stock Measures." Click on the most recent date. This
In what way has Regulation 144A of the Securities and Exchange Commission provided an incentive to the process of financial institution disintermediation? The following questions and problems are based on material in Appendix 1A to the Chapter.
What characteristics of financial products are necessary for financial markets to become efficient alternatives to financial intermediaries? Give some exam- ples of the commoditization of products which were previously the sole prop- erty of financial institutions?
What are some of the methods banking organizations have employed to re- duce the net regulatory burden? What has been the effect on profitability?
In the transmission of monetary policy, what is the difference between inside money and outside money? How does the Federal Reserve Board try to control the amount of inside money? How can this regulatory position create a cost for depository financial institutions?
What forms of protection and regulation do the regulators of Fls impose to ensure their safety and soundness?
Why are Fls among the most regulated sectors in the world? When is the net regulatory burden positive?
If financial markets operated perfectly and costlessly, would there be a need for financial intermediaries?
What is denomination intermediation? How do Fls assist in this process?
What is maturity intermediation? What are some of the ways the risks of ma- turity intermediation are managed by financial intermediaries?
How do Fls alleviate the problem of liquidity risk faced by investors who wish to invest in the securities of corporations?
What is a benefit to lenders, borrowers, and financial markets in general of the solution to the information problem provided by large financial institutions?
How do Fls solve the information and related agency costs when household savers invest directly in securities issued by corporations? What are agency costs?
Identify and explain the two functions in which Fls may specialize that would enable the smooth flow of funds from household savers to corporate users.
Identify and explain three economic disincentives that probably would dampen the flow of funds between household savers of funds and corporate users of funds in an economic world without financial intermediaries.
Explain how economic transactions between household savers of funds and corporate users of funds would occur in a world without financial intermediaries.
Suppose that an FI holds two loans with the following characteristics.Calculate the return and risk on the two-asset portfolio using Moody’s Analytics Portfolio Manager.
The Bank of Tinytown has two $20,000 loans with the following characteristics: Loan A has an expected return of 10 percent and a standard deviation of returns of 10 percent. The expected return and standard deviation of returns for loan B are 12 percent and 20 percent, respectively.a. If the
A manager decides not to lend to any firm in sectors that generate losses in excess of 5 percent of capital.a. If the average historical losses in the automobile sector total 8 percent, what is the maximum loan a manager can lend to firms in this sector as a percentage of total capital?b. If the
Go to the Federal Reserve Board’s website at www.federalreserve.gov and update Table 10–7 using the following steps. Click on “All Statistical Releases.”Click on “Consumer Credit.” This downloads a file onto your computer that contains the relevant data. How have consumer loan rates
Go to the Federal Housing Finance Agency’s website at www.fhfa.gov and find the most recent data on the percentage of conventional single-family mortgages with adjustable rates using the following steps. Under “Research& Analysis,” then “Market Data,” and then “Monthly Interest Rate
Go to the Federal Reserve Board’s website at www.federalreserve.gov and update the data in Table 10–1 using the following steps. Click on “All Statistical Releases.” Click on “Assets and Liabilities of Commercial Banks in the U.S.” This downloads a file onto your computer that contains
Consider the following company balance sheet and income statement.Balance Sheet Assets Liabilities and Equity Cash $ 4,000 Accounts payable $ 30,000 Accounts receivable 52,000 Notes payable 12,000 Inventory 40,000 Total current liabilities 42,000 Total current assets 96,000 Long-term debt 36,000
A score between 120 and 190 (noninclusive) is reviewed by a loan committee for a final decision.
Suppose you are a loan officer at Carbondale Local Bank. Joan Doe listed the following information on her mortgage application.Use the information below to determine whether or not Joan Doe should be approved for a mortgage from your bank.The loan is automatically rejected if the applicant’s
A firm has assets of $200,000 and total debts of $175,000. With an option pricing model, the implied volatility of the value of the firm’s assets is estimated at $10,730. Under the Moody’s Analytic method, what is the expected default frequency (assuming a normal distribution for assets)?
A bank is planning to make a loan of $5,000,000 to a firm in the steel industry.It expects to charge a servicing fee of 50 basis points. The loan has a maturity of 8 years with a duration of 7.5 years. The cost of funds (the RAROC benchmark) for the bank is 10 percent. The bank has estimated the
The table below shows the dollar amounts of outstanding bonds and corresponding default amounts for every year over the past five years. Note that the default figures are in millions, while those outstanding are in billions. The outstanding figures reflect default amounts and bond redemptions.Years
The following is a schedule of historical defaults (yearly and cumulative) experienced by an FI manager on a portfolio of commercial and mortgage loans.a. Complete the blank spaces in the table.b. What are the probabilities that each type of loan will not be in default after five years?c. What is
The bond equivalent yields for U.S. Treasury and A-rated corporate bonds with maturities of 93 and 175 days are given below:93 Days 175 Days Treasury strip 8.07% 8.11%A-rated corporate 8.42 8.66 Spread 0.35 0.55a. What are the implied forward rates for both an 82-day Treasury and an 82-day A-rated
Calculate the term structure of default probabilities over three years using the following spot rates from the Treasury strip and corporate bond (pure discount) yield curves. Be sure to calculate both the annual marginal and the cumulative default probabilities.Spot 1 Year Spot 2 Year Spot 3 Year
For the second year, suppose that 1 p2 0.05. Calculate the cumulative probability of default over the next two years.
Suppose an FI manager wants to find the probability of default on a two-year loan. For the one-year loan, 1 p1 0.03 is the marginal and total or cumulative probability ( Cp ) of default in year
Assume that a one-year Treasury strip is currently yielding 5.5 percent and an AAA-rated discount bond with similar maturity is yielding 8.5 percent.a. If the expected recovery from collateral in the event of default is 50 percent of principal and interest, what is the probability of repayment of
MNO Inc., a publicly traded manufacturing firm in the United States, has provided the following financial information in its application for a loan. All numbers are in thousands of dollars.Assets Liabilities and Equity Cash $ 20 Accounts payable $ 30 Accounts receivable 90 Notes payable 90
Suppose the estimated linear probability model used by an FI to predict business loan applicant default probabilities is PD 0.03 X1 0.02 X2 0.05 X3 error, where X1 is the borrower’s debt/equity ratio, X2 is the volatility of borrower earnings, and X3 is the borrower’s profit ratio. For a
Suppose there were two factors influencing the past default behavior of borrowers: the leverage or debt–assets ratio ( D / A ) and the profit margin ratio ( PM ).Based on past default (repayment) experience, the linear probability model is estimated as:PD D A PM 0.105( / ) 0.35( ) i ii
Although not mentioned in Appendix 9A, for a given percentage ()change in interest rates, the increase in price for a decrease in rates is greater than the decrease in value for an increase in rates.The following questions and problems are based on material in Appendix 9B to the chapter.
The change in value of longer-term fixed-rate financial assets increases at a decreasing rate.Rule
The longer is the maturity of a fixed-income financial asset, the greater is the change in price for a given change in interest rates.Rule
Interest rates and prices of fixed-rate financial assets move inversely.Rule
Consider a $1,000 bond with a fixed-rate 10 percent annual coupon rate and a maturity ( N ) of 10 years. The bond currently is trading at a yield to maturitya. Complete the following table:b. Use this information to verify the principles of interest rate–price relationships for fixed-rate
A financial institution has an investment horizon of two years 9.33 months(or 2.777 years). The institution has converted all assets into a portfolio of 8 percent, $1,000 three-year bonds that are trading at a yield to maturity of 10 percent. The bonds pay interest annually. The portfolio manager
Explain how this goal changes the desired duration gap for the institution. Why does this differ from the duration gap necessary to immunize the total equity? How would your answers to part (h) in problem 24 and part (g) in problem 26 change if immunizing equity to total assets was the goal?
Assume that a goal of the regulatory agencies of financial institutions is to immunize the ratio of equity to total assets, that is, Δ( E / A )
The following balance sheet information is available (amounts in thousands of dollars and duration in years) for a financial institution:Amount Duration T-bills T-notes T-bonds Loans Deposits Federal funds Equity$ 90 55 176 2,724 2,092 238 715 0.50 0.90 x7.00 1.00 0.01 Treasury bonds are five-year
The balance sheet for Gotbucks Bank Inc. (GBI) is presented below ($ millions).Assets Liabilities and Equity Cash Federal funds Loans (floating)Loans (fixed)$ 30 20 105 65 Core deposits Federal funds Euro CDs Equity$ 20 50 130 20 Total assets $220 Total liabilities and equity $220a. What is the
Financial Institution XY has assets of $1 million invested in a 30-year, 10 percent semiannual coupon Treasury bond selling at par. The duration of this bond has been estimated at 9.94 years. The assets are financed with equity and a $900,000, two-year, 7.25 percent semiannual coupon capital note
Consider the case in which an investor holds a bond for a period of time longer than the duration of the bond, that is, longer than the original investment horizon.a. If interest rates rise, will the return that is earned exceed or fall short of the original required rate of return? Explain.b. What
Two bonds are available for purchase in the financial markets. The first bond is a two-year, $1,000 bond that pays an annual coupon of 10 percent. The second bond is a two-year, $1,000 zero-coupon bond.a. What is the duration of the coupon bond if the current yield to maturity (R)is 8 percent? 10
A one-year, $100,000 loan carries a coupon rate and a market interest rate of 12 percent. The loan requires payment of accrued interest and one-half of the principal at the end of six months. The remaining principal and the accrued interest are due at the end of the year.a. What will be the cash
What are the two different general interpretations of the concept of duration, and what is the technical definition of this term? How does duration differ from maturity?
What is the impact over the next year on net interest income if interest rates on RSAs increase 60 basis points and on RSLs increase 40 basis points?1 . What is the difference between book value accounting and market value accounting? How do interest rate changes affect the value of bank assets and
What is the repricing gap if the planning period is 30 days? 6 months? 1 year? 2 years? 5 years?
You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning two years from today, 2 f1 ?Maturity Yield One day 2.00%One year 5.50 Two years 6.50 Three years 9.00
The Wall Street Journal reports that the rate on three-year Treasury securities is 5.25 percent and the rate on four-year Treasury securities is 5.50 percent. The one-year interest rate expected in year four, E ( 4r1 ), is 6.10 percent. According to the liquidity premium hypothesis, what is the
Based on economists’ forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows: 5.65%( ) 6.75% 0.05%( ) 6.85% 0.10%( ) 7.15% 0.12%1 1 2 1 2 3 1 3 4 1 4 REr L Er L Er L Using the liquidity premium hypothesis, plot the
The Wall Street Journal reports that the rate on three-year Treasury securities is 5.60 percent and the rate on four-year Treasury securities is 5.65 percent.According to the unbiased expectations hypothesis, what does the market expect the one-year Treasury rate to be in year 4, E ( 4r1 )?
The Wall Street Journal reported interest rates of 6 percent, 6.35 percent, 6.65 percent, and 6.75 percent for three-year, four-year, five-year, and six-year Treasury notes, respectively. According to the unbiased expectations theory, what are the expected one-year rates for years 4, 5, and 6?
The current one-year Treasury bill rate is 5.2 percent, and the expected one-year rate 12 months from now is 5.8 percent. According to the unbiased expectations theory, what should be the current rate for a two-year Treasury security?
Suppose that the current one-year rate (one-year spot rate) and expected oneyear T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:1 1 R Er Er Er 6% ( ) 7% ( ) 7.5% ( ) 7.85% 2 1 3 1 4 1 Using the unbiased expectations theory, calculate the
EDF Bank has a very simple balance sheet. Assets consist of a two-year,$1 million loan that pays an interest rate of LIBOR plus 4 percent annually.The loan is funded with a two-year deposit on which the bank pays LIBOR plus 3.5 percent interest annually. LIBOR currently is 4 percent, and both the
Gunnison Insurance has reported the following balance sheet (in thousands):Assets Liabilities and Equity 2-year Treasury note $175 1-year commercial paper $135 15-year munis 165 5-year note 160 Equity 45 Total assets $340 Total liabilities and equity $340 All securities are selling at par equal to
The following is a simplified FI balance sheet:Assets Liabilities and Equity Loans $1,000 Deposits $ 850 Equity 150 Total assets $1,000 Total liabilities and equity $1,000 The average maturity of loans is four years and the average maturity of deposits is two years. Assume that loan and deposit
If a bank manager is certain that interest rates are going to increase within the next six months, how should the bank manager adjust the bank’s maturity gap to take advantage of this anticipated increase? What if the manager believes rates will fall? Would your suggested adjustments be difficult
County Bank has the following market value balance sheet (in millions, all interest at annual rates). All securities are selling at par equal to book value.a. What is the maturity gap for County Bank?b. What will be the maturity gap if the interest rates on all assets and liabilities increase 1
Nearby Bank has the following balance sheet (in millions):Assets Liabilities and Equity Cash $ 60 Demand deposits $140 5-year Treasury notes 60 1-year certificates of deposit 160 30-year mortgages 200 Equity 20 Total assets $320 Total liabilities and equity $320 What is the maturity gap for Nearby
What are some of the weaknesses of the repricing model? How have large banks solved the problem of choosing the optimal time period for repricing?What is runoff cash flow, and how does this amount affect the repricing model’s analysis?The following questions and problems are based on material in
A bank has the following balance sheet:Assets Avg. Rate Liabilities/Equity Avg. Rate Rate sensitive $225,000 6.35% Rate sensitive $300,000 4.25%Fixed rate 550,000 7.55 Fixed rate 505,000 6.15 Nonearning 120,000 Nonpaying 90,000 Total $895,000 Total $895,000 Suppose interest rates rise such that the
The balance sheet of A. G. Fredwards, a government security dealer, is listed below. Market yields are in parentheses, and amounts are in millions.Assets Liabilities and Equity Cash $ 20 Overnight repos $340 1-month T-bills (7.05%) 150 Subordinated debt 3-month T-bills (7.25%) 150 7-year fixed rate
A bank has the following balance sheet:Assets Avg. Rate Liabilities/Equity Avg. Rate Rate sensitive $ 550,000 7.75% Rate sensitive $ 575,000 6.25%Fixed rate 755,000 8.75 Fixed rate 605,000 7.50 Nonearning 265,000 Nonpaying 390,000 Total $1,570,000 Total $1,570,000 Suppose interest rates fall such
A bank has the following balance sheet:Assets Avg. Rate Liabilities/Equity Avg. Rate Rate sensitive $ 550,000 7.75% Rate sensitive $ 375,000 6.25%Fixed rate 755,000 8.75 Fixed rate 805,000 7.50 Nonearning 265,000 Nonpaying 390,000 Total $1,570,000 Total $1,570,000 Suppose interest rates rise such
Consider the following balance sheet for WatchoverU Savings Inc. (in millions):Assets Liabilities and Equity Floating-rate mortgages(currently 10% annually) $ 50 1-year time deposits(currently 6% annually) $ 70 30-year fixed-rate loans(currently 7% annually) 50 3-year time deposits(currently 7%
A bank manager is quite certain that interest rates are going to fall within the next six months. How should the bank manager adjust the bank’s six-month repricing gap and spread to take advantage of this anticipated rise? What if the manager believes rates will rise in the next six months?
Which of the following assets or liabilities fit the one-year rate or repricing sensitivity test?3-month U.S. Treasury bills 1-year U.S. Treasury notes 20-year U.S. Treasury bonds 20-year floating-rate corporate bonds with annual repricing 30-year floating-rate mortgages with repricing every two

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Financial Institutions Management 8th Edition Anthony Saunders, Marcia Cornett - Solutions

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