Calculate Size, Cost of Reducing Asset Base And Purchased Liquidity Management Of A Bank

Question

Assets

Liabilities and Equity

Cash Required Reserves

$2 million

Deposits

$8 million

Loans

$10 million

Long-term Debt

$2 million

 

 

Equity

$2 million

Total

$12 million

Total

$12 million

 

The average interest earned on the loans is 6 percent and the average cost of deposits is 5 percent. Rising interest rates are expected to reduce the deposits by $3 million. Borrowing more debt will cost the bank 5.5 percent in the short term.

1. What will be the size of the bank if a stored liquidity management strategy is adopted?
    a. $9 million.
    b. $11 million.
    c. $12 million.
    d. $14 million.
    e. $15 million.

2. What will be the cost of using a strategy of reducing its asset base to meet the expected decline in deposits? Assume that the bank intends to keep $2 million in cash as a liquidity precaution.
    a. $10,000.
    b. $15,000.
    c. $30,000.
    d. $40,000.
    e. $50,000.

3. What will be the cost of using a strategy of purchased liquidity management to meet the expected decline in deposits? Assume that the bank intends to keep $2 million in cash as liquidity precaution.
    a. $10,000.
    b. $15,000.
    c. $30,000.
    d. $40,000.
    e. $50,000.

4. What will be the size of the bank if a purchased liquidity management strategy is adopted?
    a. $9 million.
    b. $11 million.
    c. $12 million.
    d. $14 million.
    e. $15 million.

Summary

These questions belong to Finance and it is about a scenario where a bank’s average interest on loans is 6% and average cost of deposits is 5% and borrowing more debt will cost the bank more. Questions about this scenario such as the size of the bank, cost of reducing asset base and purchased liquidity management, etc have been answered in the solution in detail.

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