liquidity risk
Please show enough of your work that I can determine how you obtain your answers, (e.g, by turning in the spreadsheet you use to do the calculations). If you make other assumptions, please state them clearly.Each subpart is worth 10 points.
1. A depository institution (DI) has the following balance sheet (all amounts are in millions). It expected a deposit drain of $25 million.
Assets Deposits
Cash $20 Deposits $134
Loans 100 Borrowed funds 22
Securities 45 Equity 9
Total assets 165 Total liabilities and equity 165
a. Show the DI’s balance sheet if it uses purchased liquidity management to offset the expected drain.
b. Show the DI’s balance sheet if it uses stored liquidity management to offset the expected drain.
2. A DI has assets of $25 million consisting of:
Cash – $3 million, and
Loans – $22 million.
Its liabilities are:
Core deposits – $15 million,
CDs – $6 million,
repurchase agreements – $1 million,and
subordinated debt – $1 million.
It has equity of $2 million.
Increases in interest rates are expected to cause a net drain of $4 million in core deposits over the next year.
a. On average, deposits cost 4% and the average yield on loans is 7%. The DI decides to reduce its loan portfolio to offset the expected decline in deposits. What will be the effect on net interest income and the size of the DI after the implementation of this strategy?
b. If the interest cost of issuing new short term debt (CD’s or repurchase agreements) is expected to be 5.5%, what would be the effect on net interest income and size of the DI if the expected deposit drain is offset by an increase in these interest bearing liabilities?
c. What other factors may make the DI prefer the strategy in part b to that in part a?
3. A financial institution has the following assets (market values):
$120 million in cash reserves,
$120 million in Treasury bills and notes,
$200 million in mortgage loans,
$40 million in corporate bonds, and
$150 million in commercial loans.
If assets are liquidated on short notice, the institution expects to receive
99% of the fair market value of the treasury debt,
90% of the fair market value of the mortgages,
95% of the fair market value of the bonds, and
$75% of the fair market value of the commercial loans.
a. What is the financial institution’s liquidity index?
b. How can the financial institution use this information is managing its liquidity risk?
4. A bank has $5 million in cash and cash equivalents, $15 million in loans, and $8 million in core deposits.
a. What is the bank’s financing gap?
b. What is the bank’s financing requirement?
c. How can this information be used in the day-to-day liquidity management of the bank?