Week 1 • Chapter 1: Page 27 Question 8 8. List and describe the different channels that banks use to deliver banking services. For each, describe the characteristics of the customers who will likely be active users of services in that channel. • Chapter 2: Page 64 Questions 8 and 11 8. Change is always good for some participants and bad for others. Which types of financial institutions appear best situated to gain from potential changes in the regulatory structure within the financial services arena? Which institutions seem most likely to lose? 11. What are the basic arguments for increasing capital requirements at large commercial banks? In what ways will depositors, stockholders, and society in general benefit? How might each group be disadvantaged? As commercial banks enter new lines of business such as brokerage, how much additional capital should be required? Should these new lines of business be insured by the FDIC? Why or why not? Give examples from today’s financial marketplace. • Chapter 7: Page 278 Questions 9 and 10 9. Assume that you manage the interest rate risk position for your bank. Your bank cur- rently has a positive cumulative GAP for all time intervals through one year. You expect that interest rates will fall sharply during the year and want to reduce your bank’s risk position. The current yield curve is inverted with long-term rates below short-term rates. a. To reduce risk, would you recommend issuing a three-month time deposit and investing the proceeds in one-year T-bills? Will you profit if rates fall during the year? b. To reduce risk, would you recommend issuing a three-month time deposit and making a twoyear commercial loan priced at prime plus 1 percent? Why? 10. Your bank has 50 percent of its loans priced off the current prime rate at prime plus 1 percent, on average. The majority of the bank’s liabilities are interest-bearing core deposits (NOWs, MMDAs, and small time deposits). a. Assume that the prime rate immediately rises from 6 percent to 6.5 percent. Will management likely increase deposit rates by 0.50 percent immediately? Explain why or why not. What will be the impact on the bank’s spread? b. Assume that the prime rate immediately falls from 6 percent to 5.5 percent. Will management likely decrease deposit rates by 0.50 percent immediately? Explain why or why not. What will be the impact on the bank’s spread? • • • • • • • • • • Week 2 • Chapter 8: Page 306 & 307 Questions 5 and 10 5. A 5-year zero coupon bond and a 15-year zero coupon bond both carry a price of $7,500 and a market rate of 8 percent. Assuming that the market rates on both bonds fall to 7 10. Suppose that your bank currently operates with a DGAP of 2.2 years. Which of the following will serve to reduce the bank’s interest rate risk? a. Issue a one-year zero coupon CD to a customer and use the proceeds to buy a three-year zero coupon Treasury bond. b. Sell $5 million in one-year bullet (single payment) loans and buy three-month Treasury bills. c. Obtain two-year funding from the Federal Home Loan Bank and lend the proceeds overnight in the federal funds market. • Chapter 10: Page 407& 408 Questions 17 and 20 17. Explain how each of the following will affect a bank’s deposit balances at the Federal Reserve: a. The bank ships excess vault cash to the Federal Reserve. b. The bank buys U.S. government securities in the open market. c. The bank realizes a surplus in its local clearinghouse processing. d. The bank sells federal funds. e. A $100,000 certificate of deposit at the bank matures and is not rolled over. f. Local businesses deposit tax payments in the Treasury’s account at the local bank. 20. What can a bank do to increase its core deposits? What are the costs and benefits of such efforts? Generally, how might management estimate the relative interest elastic- ity of various deposit liabilities of a bank? • • • • • • • • • • • • • • • • • • • • • • Week 3 • Chapter 11: Page 445 Questions 3 and 4 3. Monetary theory examines the role of excess reserves (actual reserves minus required reserves) in influencing economic activity and Federal Reserve monetary policy. Viewed in the context of a single bank, excess reserves are difficult to measure. Explain what amount of a bank’s actual reserve assets are excess reserves during any single day in the reserve maintenance period under lagged reserve accounting. 4. Which of the following activities will affect a bank’s required reserves? a. The local Girl Scout troop collects coins and currency to buy a new camping stove. The troop deposits $250 in coins and opens a small time deposit. b. You decide to move $200 from your MMDA to your NOW account. c. You sell your car to the teller at your bank for $5,000. The teller pays with a check drawn on the bank, and you deposit the check immediately into your checking account at the bank. • Chapter 13: Page 522 & 523 Questions 7 and 13 7. 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 expenditures may not exceed $10 million annually. 13. 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 • Chapter 14: Page 575 Questions 9 and 12 9. 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 dividend. f. Firm sells its product on credit. g. Firm buys a new fleet of trucks. 12. 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 advan- tages and disadvantages of the following sources of cash as the primary source of repayment on a loan Selling an asset Generating more sales Issuing stock (equity) Increasing a liability Decreasing expenses Reducing cash dividends Under what circumstances would you be comfortable with the mentioned sources being the “primary” source of repayment?
 

Chapter 1

8).

• Mobile banking- A channel that enables customers to use their mobile phones to access banking services. Young people will prefer this channel of service delivery because of their increased knowledge of technology.
• Internet banking- This is done through secured websites where customers are able to transfer funds through wire transfer, pay bills, and apply for loans online. Young people prefer this channel of service delivery because of their increased knowledge of technology.
• Automated Teller Machine- These are computer-assisted systems that allow customers to get unlimited bank services. There is no human intervention while using the ATMs. Both young and older people prefer this channel of service delivery because of their increased knowledge of technology.
• Branch banking includes brick and mortar, which provide a wide range of bank services such as loans and deposits, and instore banking, which includes agents and retail outlets. They offer limited bank services such as no offering of loans.

Chapter 2

8). Financial institutions.

Monetary and financial transactions, investment strategy, offering loans to medium-sized and small businesses, lending money to customers, capital formation, and pension plans are some functions that financial institutions perform.

Infosys, the State Bank of India, ICICI Bank, and HDFC Bank are examples of financial institutions that embrace regulatory structure changes because it helps in improving the productivity of the institutions, thus developing greater efficiency. It decreases unnecessary costs, helps in revenue generation, and facilitates the efficient functioning of the investments. Grameen and Regional Rural Banks are likely to lose because of the current regulatory financial changes that are not embraced by the rural individuals, quickly making it hard for such financial institutions to make a change and work under the current structure.

11). The primary argument is that the risk is lesser if the bank increases its capital. In other words, improved capital in a bank brings down the risk. This conceivably benefits depositors is by lessening the probability of deposit runs or bank runs. The stockholders grow since their venture is more secure, and as of late, the stock market has joined a premium to the banks with generous equity value since they are seen to be more secure with better expansion prospects. Society is usually advantaged since safe banks are bound to loan. Additional capital ought to be mandatory as banks and different firms provide non-traditional products. This aspect is not considered suitable for the Federal Deposit Insurance Corporation (FDIC) to safeguard different lines of products or business since firms should possibly offer them if they are eager to acknowledge and ready to handle the risk. Firms ought to be permitted to fail when they function inadequately. One approach to require capital is to calculate approximately or roughly the riskiness of the line of business with respect to different activities of the firm. The higher the perceived risk, the higher the capital requirements must be. Maybe capital requirements ought to be connected to the volatility in returns of the line of business.

Chapter 7

9). a). Yes, because I expect the rate of interest to decrease steadily during the year. Therefore, I ensure that my fixed income after a year at an increased rate of interest by investing in the t-bills of 1 year. Similarly, I have given a 3-month short time for making deposits at the increased rate, which, after the elapse of the three months, the interest may reduce. Because of this, rates of interest of the expenses of the bank will decrease while that of income will increase. Thus the bank will be able to make profits from the fall of the rates.

b). the loan issued at the prime plus 1 percent is on the basis of a fluctuating index based on the interest rate movements in the market. There is an anticipated fall in the rate of interest in the following year. Thus we had issued a 3-month short time for making deposits at the increased rate, which, after the elapse of the three months, the interest may reduce. Therefore, the interest earned will increase by 1 percent compared to the bank's interest expense, thereby reducing risks.

10). a). the bank would not raise deposit rates immediately because most of the liabilities of the bank have short-term maturity. Short-term deposit customers are less sensitive to prices because their interest lies in quick liquidity. Thus an increase in the rate of interest would make the net interest income reduce. On the other hand, the bank would raise the rate of interest immediately on loans offered since they are priced at prime plus 1%, thus would help in increasing the interest rate spread of the bank.

b). Yes, the bank should decrease the rates of the deposit immediately to safeguard its interest expenses from increasing. A reduction in the prime rate would cause the bank's interest income to reduce, thus reducing the rate of interest spread of the bank. If it reduces the rates of deposit, the rate of interest will decrease, thus increasing the spread of the bank.

Week 2

Chapter 8

5).

For 5-year zero coupon = {(ΔP/P) = D/ (1+i) x Δi}

                                           {(5/(1+0.08) x (-0.01) = 0.0463

                                                = 4.63% as the percentage increase in bond price.

For 15-year zero coupon = {(ΔP/P) = D/ (1+i) x Δi}

                                          {(15/(1+0.08) x (-0.01) = 0.1389

                                                = 13.89% increase in bond price.

10). The Correct answer is choice b and c

Chapter 10

17). a). Shipping of excess vault cash by the bank would result in a decrease in cash availability with the bank, and the bank's deposit with Federal Reserve would rice

b). liquidity with the bank will decrease if it purchases government securities. Securities may come from the Federal Reserve. The deposit of the bank with the Federal Reserve is at risk when the bank buys securities.

c). the balance of cash availability with the bank rises when a surplus in the bank's local clearinghouse is realized. The surplus funds are deposited with the Federal Reserve. This will lead to an increase in the Federal Reserve.

d). when the bank sells feral funds, fund availability with the bank rises. Therefore, the bank may is able to transfer to the Federal Reserve its excess funds.

e). The deposit certificate is not rolled means that it is not answered. This makes the certificate to be renewed automatically, and the money can not be withdrawn. The bank is therefore liable to pay the sum to the customer. This will negatively affect cash availability with Federal Reserve and the bank.

f). Tax payment deposition into the account of the local bank’s treasury will lead to an increase in the deposits with the bank. The part of the demand amount deposit with the Federal Reserve is parked by the Local Bank.

20). Banks that have the capacity to maintain their core deposits provide several types of services so that it becomes costly to move an account in terms of time, effort, and loss of personal relationship with the bank. It is not a complicated issue to combine several services and products with a checking bank account. This is done mainly to keep the customers of a particular bank. Overall, banks are the capacity for estimating elasticities of interest from their recent experience of deposits when other top competitors decrease or increase the rates of deposits or when the bank changes its deposit rates relative to its top competitors. Alternatively, it is possible for banks to carry out market surveys.

Week 3

Chapter 11

3). Lagged reserve accounting is described as a system that banks use when determining the amount that is stored for their daily transactions in the Federal Reserve. The Federal Reserve requires that the banks keep at minimum 10 percent of outstanding deposit demands as cash. There is no provision within the rule that accepts a cap on the deposit time accounts. For example, if a particular bank has a sum of ten million USD in the demand deposit account and sixty million USD in the time deposit account before the current day but within two weeks, the bank is mandated to hold one million USD cash with the Federal Reserve and make use of the rest for other activities such as lending and investments. Suppose the particular bank holds more than ten million USD with the federal reserve, then any cash amount more than ten million USD is said to be an excess of the bank’s reserve.

4). A is the correct answer.

Chapter 13

7). a). The covenant makes sure that cash outflows are effectively controlled, and the savings that arise from the cash flows are used for increasing earnings leading to the internal growth of the firm.

b). The covenant assists the bank in checking the obligations of the debt and the cash flow differences frequently. This assists the bank in gaining a cash flows overview for a given period.

c). The covenant poses a restriction to the borrower so that they do not accumulate excess inventory by disposing of the older one. This will ensure that the inventory is churned five times annually.

d). The covenant poses a restriction to the investment behavior of the customers. The cap of ten million USD prevents the firm from facing a default risk by over-investing.

13). Only a, c, and d can be securitized because they have a known default probability and track records. Loans to farmers are not possible to be securitized because of the unknown probability of default thus has a higher risk. Small business loans also are not possible to be securitized since they have unreliable financial statements, lack of track record, and absence of history.

Chapter 14

9). a). Source of cash b) Use of cash c). No impact on cash d). Source of cash e). Use of cash

f). Source of cash g). Use of cash

12). It is critical to identify the primary repayment sources because it is a liability. It will require that it is repaid. However, if the source is considered an asset, there will be no need for refunds.

Selling an asset: The advantage is that there is a generation of large cash inflow, and there is a lesser cost for arranging funds. However, the advantage is that there is a loss of the capacity to generate income permanently. The above source is comfortable under the circumstance that the asset is not used for business operations anymore.

Increasing liability: The advantage of this is that similar terms may be arranged, and there is like for like loan replacement. The disadvantage of this is that interest on interest is to be paid, and it is mandatory to repay the liability. The above source is comfortable under the circumstance that the loan terms are favorable compared to the discharged loan.

Generating more sales: the advantage of this is that there is an increase in profitability. Since it has no disadvantages, the source is comfortable under every circumstance.

Decreasing expenses: the advantage of this is that there is an increase in profitability. However, the disadvantage is that there is a greater need to assess if the business is compacted. The above source is comfortable under the circumstance that there is no business operations impact.

Issuing equity: the advantage of this is that there is lower cash outflow, and since there is no payment, it is considered a permanent option. The disadvantage is that there is a dilution of equity. The above source is comfortable under the circumstance that WACC decreases when equity is issued.

Reducing cash dividends: the disadvantage of this is that there is a low valuation of equity while the advantages are a permanent option and lower cash outflow. The above source is comfortable under the circumstance that there is no decrease or fall in equity share valuation.  

OUTLINE

I. Cover page: Student Name, Name of professor, Course, and Date.

II. Week 1 sampled chapter answers

Chapter 1: Explanations to question 8

Chapter 2: Explanation to questions 8 and 11

Chapter 7: Explanations to 9 and 10

III. Week 2 sampled chapter answers

Chapter 8: Explanations to question 5 and 10

Chapter 10: Explanation to questions 17 and 20

IV. Week 3 sampled chapter answers

Chapter 11: Explanations to question 3 and 4

Chapter 13: Explanation to questions 7 and 13

Chapter 14: Explanations to 9 and 112