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    Bank excess funds

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    A new client just deposited $300,000 in a corporate checking account. Idle money means missing out on profits, so we want to put the additional funds to good use as soon as possible. We've identified three potential options for using the additional funds?you should evaluate the profitability and risk implications of each of the options.

    ? Purchase additional government bonds. The selected securities are expected to yield about 4 percent per year.
    ? Purchase long-term AAA corporate bonds. The selected securities are expected to yield 7 percent per year.
    ? A loan to a local businessman to expand his business. The loan would have an interest rate of 10 percent.

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    Solution Preview

    I need to recommend a course of action for the bank to pursue with a large new deposit. It should include:

    ? explain how the new deposit will affect the bank's balance sheet and reserve requirements
    The new deposit is $300,000; this will increase the checkable deposits by $300,000. In other words the checkable deposits will increase to $4, 500, 000. On the other hand as the deposits have been received by check the cash reserves will increase by $300,000. An increase in checkable deposits by $300,000 means there is an increase in the reserve requirements by 10 percent of $300,000 that is $30,000. So the requirement for reserves increases by $30,000 to $450,000.

    ? identify the maximum amount of the deposit that can be used to acquire new assets.
    The maximum amount of the deposits that can be used to acquire new assets is $300,000 less reserve $30,000 = $ 270,000. So, $270,000 can be used to acquire new assets.

    ? briefly describe, for each potential use of the funds, how the transaction would affect the bank's balance sheet and discuss how each option would affect the various risks faced by the bank (e.g., leverage risk, credit risk, interest rate risk, ...

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