1、3-1ANSWERS TO QUESTIONS FOR CHAPTER 3(Questions are in bold print followed by answers.)1. Explain the ways in which a depository institution can accommodate withdrawal and loan demand.A depository institution can accommodate loan and withdrawal demands first by having sufficient cash on hand. In add
2、ition it can attract more deposits, borrow from the Fed or other banks, and liquidate some of its other assets.2. Why do you think a debt instrument whose interest rate is changed periodically based on some market interest rate would be more suitable for a depository institution than a long-term deb
3、t instrument with a fixed interest rate?This question refers to asset-liability management by a depository institution. An adjustable rate can eliminate or minimize the mismatch of maturity risk. As interest rates rise, the institution would have to pay more for deposits, but would also receive high
4、er payments from its loan.3. What is meant by:a. individual bankingb. institutional bankingc. global bankinga. Individual banking is retail or consumer banking. Such a bank emphasizes individual deposits, consumer loans and personal financial trust services.b. An institutional bank caters more to co
5、mmercial, industrial and government customers. It issues deposits to them and tries to meet their loan needs.c. A global bank encompasses many financial services for both domestic and foreign customers. It is much involved in foreign exchange trading as well as the financial of international trade a
6、nd investment.4. a. What is the Basel Committee for Bank Supervision?b. What do the two frameworks, Basel I and Basel II, published by the Basel Committee for Bank Supervision, address regarding banking?a. It is the organization that plays the primary role in establishing risk and management guideli
7、nes for banks throughout the world. b. The frameworks set forth minimum capital requirements and standards. 3-25. Explain each of the following:a. reserve ratiob. required reservesa. The reserve ratio is the percentage of deposits a bank must keep in a non-interest-bearing account at the Fed.b. Requ
8、ired reserves are the actual dollar amounts based on a given reserve ratio.6. Explain each of the following types of deposit accounts:a. demand depositb. certificate of depositc. money market demand accounta. Demand deposits (checking accounts) do not pay interest and can be withdrawn at any time (u
9、pon demand).b. Certificates of Deposit (CDs) are time deposits which pay a fixed or variable rate of interest over a specified term to maturity. They cannot be withdrawn prior to maturity without a substantial penalty. negotiable CDs (large business deposits) can be traded so that the original owner
10、 still obtains liquidity when needed.c. Money Market Demand Accounts (MMDAs) are basically demand or checking accounts that pay interest. Minimum amounts must be maintained in these accounts so that at least a 7-day interest can be paid. Since many persons find it not possible to maintain this minim
11、um (usually around $2500) there are still plenty of takers for the non-interest-bearing demand deposits.7. How did the Glass-Steagall Act impact the operations of a bank?The Glass-Steagall Act prohibited banks from carrying out certain activities in the securities markets, which are principal invest
12、ment banking activities. It also prohibited banks from engaging in insurance activities. 3-38. The following is the book value of the assets of a bank:Asset Book Value (in millions) U.S. Treasury securities $ 50Municipal general obligation bonds 50Residential mortgages 400Commercial loans 200Total b
13、ook value $700a. Calculate the credit risk-weighted assets using the following information:Asset Risk WeightU.S. Treasury securities 0%Municipal general obligation bonds 20Residential mortgages 50Commercial loans 100b. What is the minimum core capital requirement?c. What is the minimum total capital
14、 requirement?a. The risk weighted assets would be $410BV Weight ProductUS T Sec. $50 0% 0MB 50 20% 10RM 400 50% 200CL 200 100% 200Total 700 410b. The minimum core capital is $28 million (.04X700) i.e., 4% of book value.c. Minimum total capital (core plus supplementary capital) is 32.8 million, .08X4
15、10, which is 8% of the risk-weighted assets.9. In later chapters, we will discuss a measure called duration. Duration is a measure of the sensitivity of an asset or a liability to a change in interest rates. Why would bank management want to know the duration of its assets and liabilities?a. Duratio
16、n is a measure of the approximate change in the value of an asset for a 1% change in interest rates.b. If an asset has a duration of 5, then the portfolios value will change by approximately 5% if interest rate changes by 100 basis points.10.3-4a. Explain how bank regulators have incorporated intere
17、st risk into capital requirements.b. Explain how S&L regulators have incorporated interest rate risk into capital requirements.a. The FDIC Improvement Act of 1991, required regulators of DI to incorporate interest rate risk into capital requirements. It is based on measuring interest rate sensitivit
18、y of the assets and liabilities of the bank.b. The OST adopted a regulation that incorporates interest rate risk for S&L. It specifies that if thrift has greater interest rate risk exposure, there would be a deduction of its risk-based capital. The risk is specified as a decline in net profit value
19、as a result of 2% change in market interest rate. 11. When the manager of a banks portfolio of securities considers alternative investments, she is also concerned about the risk weight assigned to the security. Why?The Basel guidelines give weight to the credit risk of various instruments. These wei
20、ghts are 0%, 20%, 50% and 100%. The book value of the asset is multiplied by the credit risk weights to determine the amount of core and supplementary capital that the bank will need to support that asset. 12. You and a friend are discussing the savings and loan crisis. She states that “the whole me
21、ss started in the early 1980s.When short-term rates skyrocketed, S&Ls got killedtheir spread income went from positive to negative. They were borrowing short and lending long.”a. What does she mean by “borrowing short and lending long”?b. Are higher or lower interest rates beneficial to an instituti
22、on that borrows short and lends long?a. In this context, borrowing short and lending long refers to the balance sheet structure of S&Ls. Their sources of funds (liabilities) are short-term (mainly deposits) and their uses (assets) are long-term in nature (e.g. residential mortgages).b. Since long-te
23、rm rates tend to be higher than short-term ones, stable interest rates would be the best situation. However, rising interest rates would increase the cost of funds for S&Ls without fully compensating higher returns on assets. Hence a decline in interest rate spread or margin. Thus lower rates, havin
24、g an opposite effect, would be more beneficial.13. Consider this headline from the New York Times of March 26, 1933: “Bankers will fight Deposit Guarantees.” In this article, it is stated that bankers argue that deposit guarantees will encourage bad banking. Explain why.The barrier imposed by Glass-
25、Steagall act was finally destroyed by the Gramm-Leach Bliley Act of 1999. This act modified parts of the BHC Act so as to permit affiliations between banks and insurance underwriters. It created a new financial holding company, which is authorized to engage in underwriting and selling securities. Th
26、e act preserved the right of state to regulate insurance activities, but prohibits state actions that have would adversely affected bank-affiliated 3-5firms from selling insurance on an equal basis with other insurance agents. 14. How did the Gramm-Leach-Bliley Act of 1999 expand the activities perm
27、itted by banks?a. Deposit insurance provides a safety net and can thus make depositors indifferent to the soundness of the depository recipients of their funds. With depositors exercising little discipline through the cost of deposits, the incentive of some banks owners to control risk-taking accrue
28、 to the owners. It becomes a “heads I win, tails you lose” situation.b. One the positive side, deposit insurance provides a comfort to depositors and thus attracts depositors to financial institutions. But such insurance carries a moral hazard, it can be costly and, unless premiums are risk-based, i
29、t forces the very sound banks to subsidize the very risky ones.15. The following quotation is from the October 29, 1990 issue of Corporate Financing Week:Chase Manhattan Bank is preparing its first asset-backed debt issue, becoming the last major consumer bank to plan to access the growing market, S
30、treet asset-backed officialsSaidAsset-backed offerings enable banks to remove credit card or other loan receivables from their balance sheets, which helps them comply with capital requirements.a. What capital requirements is this article referring to?b. Explain why asset securitization reduces capit
31、al requirements.a. The capital requirements mentioned are risk based capital as specified under the Basel Agreement, which forces banks to hold minimum amounts of equity against risk-based assets. b. Securitization effectively eliminates high risk based loans from the balance sheet. The capital requ
32、irements in the case of asset securitization are lower than for a straight loan.16. Comment on this statement: The risk-based guidelines for commercial banks attempt to gauge the interest rate risk associated with a banks balance sheet.This statement is incorrect. The risk-based capital guidelines d
33、eal with credit risk, not interest-rate risk, which is the risk of adverse changes of interest rates on the portfolio position. 17. a. What is the primary asset in which savings and loan associations invest?b. Why were banks in a better position than savings and loan associations to weather rising i
34、nterest rates?a. Savings and Loans invest primarily in residential mortgages.b. During 1980s, although banks also suffered from the effects of deregulation and rising interest rates, relatively they were in a better position than S&L association because of their 3-6superior asset-liability management.3-718. What federal agency regulates the activities of credit unions?The principal federal regulatory agency is the National Credit Union Administration.
