金融市场与金融机构基础(第3章) 英文版答案

ANSWERS 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 addition 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 debt 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 higher payments from its loan.

3. What is meant by:

a.individual banking

b.institutional banking

c.global banking

a.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 commercial, 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 and 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

guidelines for banks throughout the world.

b.The frameworks set forth minimum capital requirements and standards.

5. Explain each of the following:

a.reserve ratio

b.required reserves

a.The reserve ratio is the percentage of deposits a bank must keep in a non-interest-bearing

account at the Fed.

b.Required reserves are the actual dollar amounts based on a given reserve ratio.

6. Explain each of the following types of deposit accounts:

a.demand deposit

b.certificate of deposit

c.money market demand account

a.Demand deposits (checking accounts) do not pay interest and can be withdrawn at any time

(upon 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 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 minimum (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 investment banking activities. It also prohibited banks from engaging in insurance activities.

8. The following is the book value of the assets of a bank:

Asset Book Value (in millions)

U.S. Treasury securities $ 50

Municipal general obligation

bonds

50

Residential mortgages 400

Commercial loans 200

Total book value $700

a.Calculate the credit risk-weighted assets using the following information:

Asset Risk Weight

U.S. Treasury securities 0%

Municipal general obligation

bonds

20

Residential mortgages 50

Commercial loans 100

b.What is the minimum core capital requirement?

c.What is the minimum total capital requirement?

a.The risk weighted assets would be $410

b.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, .08X410, 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.Duration 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 portfolio’s value will change by approximately 5% if

interest rate changes by 100 basis points.

10.

a.Explain how bank regulators have incorporated interest 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 sensitivity 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 as a result of 2% change in market interest rate.

11. When the manager of a bank’s 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 weights 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 mess started in the early 1980s.When short-term rates skyrocketed, S&Ls got killed—their 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 institution 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-term 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, having 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-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. The act preserved the right of state to regulate insurance activities, but prohibits state actions that have would adversely affected bank-affiliated firms from selling insurance on an equal basis with other insurance agents.

14. How did the Gramm-Leach-Bliley Act of 1999 expand the activities permitted 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 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, it 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, Street asset-

backed officials

Said…Asset-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 capital 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

requirements 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 bank’s balance sheet.

This statement is incorrect. The risk-based capital guidelines deal 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 interest rates?

a.Savings and Loans invest primarily in residential mortgages.

b.During 1980's, 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 superior asset-liability management.

18. What federal agency regulates the activities of credit unions?

The principal federal regulatory agency is the National Credit Union Administration.