Bank Management 4th Edition Koch, Timothy W., MacDonald, S. Scott - Solutions

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Explain why an investor would be willing to pay more than book value for a bank's stock.
Describe what impact each of the following will have on a bank's adjusted book value.a. Bank owns common stock that is currently worth $90 per share, but is listed at its original acquired value of $10 per share.b. Bank has more problem loans than it has reported.c. Bank has just lost a lawsuit and
Describe what earnings dilution is in an acquisition. Explain what it means when EPS dilution is a high figure.
What types of bank risk should be considered when evaluating a merger or acquisition?
Provide a list of cost savings that might be available from a merger. How will it differ if the merger is in-market (firms serve same geographic markets with similar products) versus out-of-market?
The value of an acquisition is difficult to assess before the fact. Identify the factors that can potentially increase value. In each case, indicate where diffi- culties might arise in realizing the increased value.
Assume that you work for a large, regional bank as a junior loan officer. Your supervising officer informs you that your bank has just been acquired by a larger commercial banking organization. Assume that the other bank is lo- cated in another region of the country and has limited business
How does a bank merger differ from a bank acquisition?
Suppose that Commerce Bank in Roland 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 exchange rate
Can a trader earn covered interest arbitrage profits?
Assume that the forward exchange rate is for 90 days forward and the in- terest rates are annualized 90-day rates in Question
Suppose that the following exchange rates and interest rates prevail: Spot exchange rate: $1 = 121 yen 1-year forward rate: $1 = 130 yen 1-year interest rates: U.S. = 5.54%, Japan = 6.98% Can a trader earn covered interest arbitrage profits? If not, explain why not. If possible, determine what the
Explain how the forward market for foreign exchange differs from the spot market. When will forward exchange rates be at a premium or discount to spot exchange rates?
U.S. banks can underwrite corporate bonds and stocks outside the United States, but not in the United States. Does this seem reasonable? Why do you think such a restriction exists?
What is a bankers acceptance? Explain by setting up an example of how one is created.
Which of the following types of foreign banking operations would best suit the circumstance described?a. A major customer of a U.S. bank requests a loan to finance growing export activity in Mexico.b. Management notices that an increasing number of its business customers have located offices in
Identify several large foreign institutions that are major lenders in the United States. Do any have a basic competitive advantage over U.S. banks?Explain why.
Explain how you would measure country risk in international lending. Can you get a precise statistical measure?
Why were international banking facilities created? How do they differ from Edge Act and Agreement corporations?
Discuss the differences between Eurocurrency, Eurobonds, and Eurocredits.
How much the impact of changing interest rates either increased or decreased reported bank capital.
Whether the market value of securities held to maturity exceeds or falls below the book value;
How the bank accounts for its security holdings (review the amounts designated as trading securities, held to maturity, and available for sale);
Suppose that the bank also owned CMOs with an estimated life of 4.5 years that currently produced 8 percent coupon interest. At current interest rates the prepayment speed was 25 percent faster than normal. Discuss the pros and cons of selling these CMOs in a rising rate environment.
Suppose the bank sells the 2-year Treasury note, the 10-year Treasury bond, and the 4-year FNMA bond. Determine what dollar amount the bank will report under securities gains or losses. Analyze the incremental cash flow effects if the bank uses the proceeds after taxes to (a) buy 6- month
What will the incremental cash flow effects be over the next year if the bank sells both 4-year bonds from its portfolio and invests the entire after-tax proceeds in a new 3-year FLB bond? Is this a positive or negative net present value project? What are the advantages and disadvantages of the
Your bank is considering borrowing $1 million in 1-year funds from the Federal Home Loan Bank at 6.42 percent and buying a $1 million par value 5 NC 1 agency bond yielding 7.55 percent. The current Treasury yield curve is moderately upsloping. You currently own a Treasury bill that pays $1 million
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. If
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 semi- annual interest, with a market value of $960,000. Determine the incremen- tal cash flow effects if the bank sold this note and bought a 2-year taxable
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
Describe conceptually how static spread differs from option-adjusted spread for a callable bond?
Suppose that you own a collateralized mortgage obligation (CMO) like that in Exhibit 20.7. Explain why your total return will fall when interest rates rise. Identify changes in return associated with each component of total return.
Explain conceptually how effective duration differs from Macaulay's dura- tion for a bond with options.
Explain why the modified durations of the GNMA pass-through security in Exhibit 20.6:a. Increase when rates rise above the initial level.b. Decrease when rates fall below the initial level.
What do the terms positive convexity and negative convexity mean? Using the diagrams in Exhibit 20.4, do these securities exhibit positive convexity, negative convexity, or both? Explain.
Use the characteristics of interest only (10) mortgage-backed securities and the diagram in section B of Exhibit 20.4 to answer the following.a. Explain why the price of this IO will fall if market rates on mortgages rise above 9.5 percent.b. Suppose the current market rate on mortgages is 8
Use the characteristics of interest only (IO) mortgage-backed securities and the diagram in section B of Exhibit 20.4 to answer the following.a. Explain why the price of this IO will fall if market rates on mortgages rise above 9.5 percent.
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 5 NC 1 FNMA bond at par yielding 6.88 percent. The matched duration Treasury zero coupon
Describe the basic strategy in riding the yield curve. Can you ride the yield curve if the yield curve is downsloping with short-term rates above long- term rates?
Suppose that a bank's ALCO reports that the bank is too liability sensitive in that 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 manager pursue? Identify the cost and benefit of
Provide one reason for using the bank's investment portfolio to speculate on interest rate movements. Provide one reason against. What do you be- lieve about efficient markets and how does this influence your opinion of speculating? Can investors accurately forecast the direction of future inter-
Suppose that the U.S. Treasury yield curve is continuously downsloping.Should a bank portfolio manager buy securities with maturities under one year or securities with maturities of 10 years to maximize interest income over the next 10 years? Explain what factors should be used to make a decision.
What rationale suggests that a contracyclical investment strategy should outperform the market, on average? Is it possible to consistently earn above average returns by timing security purchases?
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?
Describe the characteristics of the laddered investment strategy and compare them to the barbell investment strategy. Why should the barbell strategy outperform the laddered maturity strategy in a stable or declining interest rate environment? Why should the laddered strategy outperform the barbell
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?
Explain how a bank's loan-to-deposit ratio is likely to affect both the size and composition of the investment portfolio. Does management first decide how many loans to make, and then allocate remaining funds to investments?
What group within a bank sets the investment policy? What issues does the policy address?
Explain why municipal securities have default risk if they are issued by government units.
Using the data in Exhibit 19.12, explain what a CAR is in terms of an asset- backed security. Why is the spread (0.48 percent) on the Class A security lower than the spread (0.63 percent) on the Class B security in terms of the features of the two instruments?
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.
Suppose that you own a 4-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.
Explain how the design of a CMO supposedly helps to manage prepay- ment risk for investors. What is a tranche?
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 MBSb. MBS issued six years prior versus MBS issued this year.c. Demographic trends in different areas of the country.
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 securities
How do banks judge the credit risk in the investment portfolio? What in- formation is available that helps?
Explain how a reverse RP differs from federal funds sold as an income pro- ducing asset.
List the objectives that banks have for buying securities. Explain the motive for each.
What is the option in a callable agency bond? What impact does the call de- ferment period have on a callable bond's promised yield? What is the pri- mary advantage of a discount callable bond versus one trading at par?
Examine the data in Exhibit 19.2. Identify key trends and explain the dri- ving force behind each.
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?
What types of securities are banks prohibited from buying for investment purposes?
Explain how zero coupon securities differ from coupon securities. Which are more liquid, in general? Which are more price sensitive? What is the ad- vantage of a zero coupon security in terms of total return?
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?
Describe how a bank makes a profit with its securities trading account.What are the risks?
Assume that Vardon will not hold any compensating balances. Relative to your analysis in question 2, what nominal interest rate should the bank charge to cover expenses and meet its target profit?
Assume that Vardon's expenses other than interest increase by 10 percent during the next year and that all other items remain constant except the weighted cost of debt, which is expected to equal 9.8 percent. Determine the nominal loan rate the bank should charge to cover expenses plus meet the 18
Using the information in Table 1, determine whether bank revenues from the account covered expenses during the year and met the bank's profit target of an 18 percent pretax return on equity.
In each of the following situations, evaluate the profitability of the cus- tomer's account relationship with the bank. Did profits meet expectations? The expense figure includes the cost of debt but not the cost of equity. Fig- ures are in millions of dollars.
Categorizing loans by risk category can be deceiving if the bank prices each higher risk category with a constant marginal premium. Explain what is wrong with this approach.
If consumer loans tend to have longer maturities than commercial loans, why are fewer consumer loans priced on a floating rate basis?
Suppose that a borrower needs $80,000. A bank gives the borrower a choice of two pricing schemes. The first is a $100,000 loan with 20 percent com- pensating balance requirements (funded from the loan) priced at 10 per- cent. The second is an $80,000 loan with no balance requirements priced at 12.5
Explain why a bank might prefer to charge a commitment fee instead of a facility fee.
What is the difference between a bank's marginal cost of debt and its mar- ginal cost of capital? Which should be used in estimating a bank's expenses and/or target profit when analyzing the profitability of a customer's ac- count relationship?
Why is LIBOR an attractive base rate for many banks and their corporate borrowers?
Are the following statements true or false? Explain why.a. The prime rate is the rate a bank charges its best (lowest risk) commer- cial borrowers.b. Commercial banks and borrowers are both better off with zero compen- sating balance requirements and a higher loan rate if the bank has to lend the
List the three primary sources of revenue from a commercial customer's ac- count. In today's economic environment, indicate whether each is growing or declining in use and explain why.
What potential problems might arise from a bank making loans that are tied to (float with) the prime rate quoted by large multinational banks and not making loans tied to the bank's own prime rate?
Loan officers and borrowers negotiate the earnings credit rate applicable to the borrower's deposit balances. What rate is appropriate theoretically? Analyze this from both the banker's and borrower's position.
Explain how ledger deposit balances differ from collected balances and in- vestable balances. Which is more restrictive to a borrower in meeting com- pensating balance requirements?
Explain generally how smart cards, debit cards, and prepaid cards differ from traditional credit cards.
Subprime loans have higher loss rates than many other types of loans. Ex- plain why lenders offer subprime loans. Describe the characteristics of the typical borrower in a subprime consumer loan.
What is the goal of the Community Reinvestment Act? How do regulators enforce its provisions?
What is the purpose of a dealer reserve in indirect lending? When is a bank at risk with indirect loans?
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 prin- cipal 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 $5,000
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?
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?
According to the data in Exhibit 17.4, credit card operations at the banks surveyed produced a negative net spread. Explain why. Does this mean that credit card operations are unprofitable?
Describe how a bank should apply an objective credit scoring model when evaluating consumer loan requests. Given the information in exhibits 17.7 and 17.8 and information in the text, indicate why you would or would not approve Melanie Groome's loan request.
What are the key provisions of the Equal Credit Opportunity Act? Why was such legislation necessary?
Explain how a direct installment loan differs from an indirect install- ment loan.
Why are home equity loans attractive today relative to before the Tax Re- form Act of 1986? How do some banks tie home equity loans to their credit card? How are home equity lines generally priced (what rates apply)?
Examine credit card loss rates and personal bankruptcy filings in Exhibit 17.2. What might explain the increase in both measures after 1994 in a pe- riod when economic growth in the United States was strong and unem- ployment was low? What will likely occur to losses and personal bank- ruptcies
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?
Explain how an installment loan differs from revolving credit in terms of risk and the nature of the return to the lender.
Develop a list of questions that a loan officer should ask Marcus Wade, from the example in the text, to gain a better understanding of the risks in lending to Wade’s Office Furniture.
Suppose that you have generated the estimates listed below from a pro forma analysis for a manufacturing company that had requested a 3-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 interest
Should a firm’s cash flow from operations generally exceed capital expenditures?
Suppose that you generate a cash-based income statement and determine that cash flow from operations 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?
Indicate whether each of the following is a source of cash, use of cash, or has no cash impact.. Firm issues new long-term debt. Firm prepays operating costs Because a firm buys another firm it amortizes goodwill Firm sells outdated computer equipment. Firm pays a stock dividend. Firm sells its

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Bank Management 4th Edition Koch, Timothy W., MacDonald, S. Scott - Solutions

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