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Monetary policy, interest rates & FDIC insurance questions

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A. Why does borrowing short and lending long present a potential problem for banks?
b. What are two effects that a government guarantee of financial institutions can have and why?
c. After a major storm cash held by individuals has increased. Should the Fed buy or sell bonds and why?
d. How does the distinction between nominal and real interest rates add uncertainty to the effect of monetary policy on the economy?
e. What are five problems in the conduct of monetary policy?

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a. Banks derive much of their earnings from the typical spread between short- and long-term interest rates. By "borrowing short and lending long," they are able to take advantage of the fact that long-term rates typically exceed short-term rates by at least a percentage point or so. The re-issue the securities which are borrowed in the interim. When the yield curve is positive (as it normally is), lending long and borrowing short manufactures spread. For an issuer routinely borrowing billions, every billion financed with five-year debt instead of ten would generate another $10,000,000 in annual earnings, every year of the first five years. But because the values of long-term instruments are much more sensitive to interest-rate changes than the values of short-term instruments, setting up a tradeoff between the expected return and interest-rate risk.

b. The Federal Deposit Insurance Corporation (FDIC) is an independent federal government agency which insures deposits in commercial banks and thrifts. A deposit insurance system can contribute to financial stability, but ...

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Monetary policy, interest rates, FDIC insurance, and bank borrowing

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Finance: M1, M2 money supply; discount rates, bank's total assets, equity capital ratio

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Following are components of the M1 money supply at the end of last year. What will be the size of the M1 money supply at the end of next year if currency grows by 10 percent, demand deposits grow by 5 percent, other checkable deposits grow by 8 percent, and the amount of traveler's checks stays the same?

Currency $700 billion
Demand deposits $300 billion
Other checkable deposits $300 billion
Traveler's checks $10 billion

Assume that a country estimates its M1 money supply at $20 million. A broader measure of the money supply, M2, is $50 million. The country's gross domestic product is $100 million. Production or real output for the country is 500,000 units or products.

a. Determine the velocity of money based on the M1 money supply.
b. Determine the velocity of money based on the M2 money supply.
c. Determine the average price for the real output

The One Product economy, which produces and sells only personal computers (PCs), expects that it can sell 500 more, or 12,500 PCs, next year. Nominal GDP was $20 million this year, and the money supply was $7 million. The central bank for the One Product economy plans to increase the money supply by 10 percent next year.

a. What was the average selling price for the personal computers this year?
b. What is the expected average selling price next year for personal computers if the velocity of money remains at this year's turnover rate? What percentage change in price level is expected to occur?
c. If the objective is to keep the price level the same next year (i.e., no inflation), what percentage increase in the money supply should the central bank plan for?
d. How would your answer in (c) change if the velocity of money is expected to be three times next year? What is it now?

The following three one-year 'discount' loans are available to you:
Loan A: $120,000 at a 7 percent discount rate
Loan B: $110,000 at a 6 percent discount rate
Loan C: $130,000 at a 6.5 percent discount rate

a. Determine the dollar amount of interest you would pay on each loan and indicate the amount of net proceeds each loan would provide. Which loan would provide you with the most upfront money when the loan takes place?
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Following are selected balance sheet accounts for Third State Bank: vault cash _ $2 million; U.S. government securities _ $5 million; demand deposits _ $13 million; non transactional accounts _ $20 million; cash items in process of collection _$4 million; loans to individuals _$7 million; loans secured by real estate _$9 million; federal funds purchased _$4 million; and bank premises _$11 million.

a. From these accounts, select only the asset accounts and calculate the bank's total assets.
b. Calculate the total liabilities for Third State Bank.
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Let's assume that you have been asked to calculate risk-based capital ratios for a bank with the following accounts:
Cash _ $5 million
Government securities _ $7 million
Mortgage loans _ $30 million
Other loans _ $50 million
Fixed assets _ $10 million
Intangible assets _ $4 million
Loan-loss reserves _ $5 million
Owners' equity _ $5 million
Trust-preferred securities _ $3 million

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purchased 15
Government Trust-preferred
securities owned 16 securities 2
Goodwill 5
Bank fixed assets 15 Owners' capital 5
Total assets $138 million Total liabilities $138 million
and owners'
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Note: The bank has loan-loss reserves of $10 million. The real estate
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e. What actions could the bank management team take to improve the bank's Tier 1 and Total Capital ratios?

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