In each subpart, show your work and provide explanation. 1. (Bank's Balance Sheet, Capital Adequacy, and Money Supply) Suppose the Krusty Krab Bank would like to (I) keep the minimum of 25% reserves of deposits, and (II) banks are legally required to maintain its total equity at 8% of risk-adjusted assets. The current balance sheet of Krusty Krab Bank is: Liabilities Assets Reserves (Cash) [0%] U.S. Treasury Securities [0%] Foreign Government Securities [50%] Loans 3,000 2,000 1,000 Deposits Long-term Convertible Debt Equity Common Stock (Tier 1) - Credit Cards [100%] 6,000 - BBB+ Corporate Loans [50%] 2,000 Loan-Loss Provision (Tier 2) The percentage in the squared bracket [] represents the risk weight of each asset. (a) (3 points) Find the risk-adjusted assets. Show your calculation. (b) (1 point) What is the fraction of reserve-to-deposits - that is, how much of a dollar deposited is kept? (c) (4 points) If all banks have similar balance sheets and households hold $20 cash on top of every $100 deposits, what is the money multiplier? Show work. (d) (4 points) Are the banks in compliance with requirements (I) and (II)? Why or why not? Explain. 12,000 1,400 Scenario 1 - In addition to requirement (II), new regulations now require banks to maintain its Tier 1 equity at 4.5% of risk-adjusted assets. (e) (4 points) Is the bank in compliance with the new regulations? Explain. Scenario 2 - In addition to Scenario 1, suppose $100 of credit cards loans are in default and written off the balance sheet. (f) (6 points) Describe the immediate change(s) to the bank's balance sheet (No need to create an entire balance sheet, simply express the change(s).) Is the bank in compliance with all the requirements? 400 200 Scenario 3 - Instead of Scenarios 1 and 2 and reverting to the balance sheet as originally provided, the Federal Reserve conducts the open market purchase of $1,000 worth of Treasury securities. That is, the Federal Reserve buys $1,000 of Treasury securities from this bank and gives $1,000 of Reserves to the bank. Scenario 4 - In addition to the transactions in Scenario 3, suppose that $64 of the Long-term Convertible Debt is also converted to Common Stock. (g) (2 points) Describe the immediate change(s) to the bank's balance sheet (No need to create an entire balance sheet, simply express the change(s).) (h) (6 points) Could the Fed's action in Scenario 3 lead to an increase in the deposits in the economy? Why or why not? Would money supply increase? Explain. (i) (4 points) If all banks have similar balance sheets and households hold $20 cash on top of every $100 deposits, what is the money multiplier after Fed's action in Scenario 3? If money multiplier has changed, explain why. Show calculation. Scenario 5 - In addition Scenarios 3 and 4, suppose the bank relaxes its own Requirement (I) of minimum reserves holding. It now desires to keep the minimum of 10% reserves of deposits. (k) (8 points) How would this change your answers to (j)? Explain. (j) (8 points) With the combined transactions in Scenario 3 -- would your answers to (h) change? Why or why not? If it is possible to make loans, what is the maximum amount the bank can lend as BBB+ corporate loans?