Question
1.As an intern with the Bank of Milan, Tennessee, you have observed that this bank makes two types of loans, agriculture loans and consumer loans
1.As an intern with the Bank of Milan, Tennessee, you have observed that this bank makes two types of loans,agriculture loans and consumer loans, and offers two types of deposits,demand deposits and time deposits. You have determined that your bank is not anasset management bankbut is aliability management bank,where core deposits plus capital are less than demand for loans. Thus your bank needs to acquire money market funds in theEurodollar market at a cost of 3.15 percent.If your bank were an asset management bank, you would invest your excess fund in treasury securities that yield an annual rate of 3.00 percent. Your bank has $2,000 in capital. Use the Economics of Banking Handout for this class. The first part of this problem, using the Demand/supply functions, proves that your bank is aliability management bank.
Demand function for agriculture loans (LA)
rA= 13.00% - .0005LA
LA=$10,000_rA=_8.0%__
Demand for function for consumer loans (LC)
rC= 9.00% - .0002LC
LC=$15,000_rC=_6.00%_
Supply function for demand deposits (DD)
rD= -4.00% + .0004375DD
DD=$8,000rD=-0.50%
Supply function for time deposits (DT)
rT= 0.00 + .00015DT
DT=$10,000rT=1.50%
Using the economics of banking theory covered in class, we show how the balance sheet for the Bank of Milan, Tennessee would appear assuming anasset management bank, where you have a problem thatdemand for assets are greater than supply of deposits plus capital.
Bank ofMilan, Tennessee
Statement of Financial Conditions (pro forma)
October 1, 2019
Assuming an Asset Management Bank
U.S. Treasury Securities$0Demand Deposits$8,000.00_
Agriculture Loans$10.000.00Time Deposits$10,000.00_
Consumer Loans$15,000.00Capital2,000.00
Total Assets$25,000.00Total Liab & NW$20,000.00_
Therefore, you need to start over assuming a liability management bank. Determine the new equilibrium balance sheet and proforma income statement.
Demand function for agriculture loans (LA)
rA= 13.00% - .0005LA
LA=$____10,000____rA=____8____%
Demand for function for consumer loans (LC)
rC= 9.00% - .0002LC
LC=$____15,000____rC= ____6_____%
Supply function for demand deposits (DD)
rD= -4.00% + .0004375DD
DD=$____8,000_____rD=_____-7.5___%
Supply function for time deposits (DT)
rT= 0.00 + .00015DT
DT=$_____10,000____rT=_____-1.5___%
Bank ofMilan, Tennessee
Statement of Financial Conditions (pro forma)
October 1, 2019
Assuming an Liability Management Bank
U.S. Treasury Securities$_______Demand Deposits$_________
Agriculture Loans$__________Time Deposits$_________
EuroDollars$__________
Consumer Loans$________Capital2,000.00
Total Assets$________Total Liab & NW$__________
Bank ofMilan, Tennessee
Income Statement (pro forma)
October 1, 2019 - September 30, 2020
Assume all rates and balances remain constant for the next year (2020 Fiscal Year)
Revenues
Interest on Treasury Securities_$_____________________________
Interest on Agriculture Loans__$_____________________________
Interest on Consumer Loans_$_____________________________
Total Interest Revenue___$_____________________________
Interest Expense
Interest on Demand Deposits___$________________________________
Interest on Time Deposits__ ___$________________________________
Interest on EuroDollars$________________________________
Total Interest Expense____$________________________________
Net Interest Revenue______$_________________________________
(15 pts)2.The following balance sheet (column 1) for "All Member Banks Combined" serves as a starting point.Assume aclosed economyand not a Global economy exists.
12
Assets
Vault Cash$84,000$84,000
Reserves at Fed Res290,400_360,000_____
Required276,000_360,000_____
Excess14,400___0______
Federal Funds Sold432,000432,000
Loans5,760,000_5,760,000______
Securities1,680,000_1,700,000_____
Other Assets1,281,6001,281,600___
Total Assets$9,528,000$____9,617,600_______
Liabilities
Demand Deposits$3,600,000$_4,195,000__________
Time Deposits4,195,2004,195,200
FF Purchased432,000432,000
Loans, Discounts and Advances14,40014,400
Other Liabilities417,600417,600
Capital Account868,800868,800
Total Liabilities + NW$9,528,000$_____9,617,600_______
In the problem, assume that reserve requirements that must be maintained in cash or at the Federal Reserve are 10% on demand deposits and 0% on time deposits. Please fill in the aggregate balance sheet for member banks for the fiscal policy problem.
a.Fill in column 2 with this part.(Assume column 1 is the starting position.)Because of the nature of the economy and the large federal deficit, the U.S. Government finances a $44,000 deficit by selling $20,000 of new bonds to banks and $24,000 of new bonds to non-banks. How would your answer possibly change in a Global economy?
Banks
AssetsLiabilities
Res ____0_____^DD $____24,000______
^Sec $___24,000_____
$___24,000____securities$____20,000_____securities
$___44,000_____DD
Private Sector
Banks
$__24,000__Demand Deposits
Bank RR = .10 ($__4,195,000_________)- 84,000 =_$_____335,500_________
(45 pts)3.Assume today's U.S. Treasury Yield Curve is given below.You can use this to estimate the average rate of inflation for the next thirty years as the difference between the nominal rate on a 30-Year Treasury bond and the Inflation Indexed Treasury bond- (often called Treasury Inflation Protected bonds or TIPs-Real Rate).The shape of the Yield Curve also tells us something about future interest rates.
U.S. Treasury Yield Curve (Nominal Rates)
Date
1 mo
2 mo
3 mo
6 mo
1 yr
2 yr
3 yr
5 yr
7 yr
10 yr
20 yr
30 yr
09/19/19
2.01
1.99
1.93
1.92
1.88
1.74
1.68
1.66
1.73
1.79
2.04
2.22
U.S Treasury Yield Curve (Real Rates-TIPS)
DATE
5 YR
7 YR
10 YR
20 YR
30 YR
09/19/19
0.25
0.21
0.18
0.38
0.57
Your 25 year old client wants to retire whenheis 70 years old, and have a retirement income equivalent to$8,000 per monthin today's (inflation adjusted) dollars. To estimate the market expectations for average annual inflation for the next 45 years, use the difference between the nominal rate and real rate on TIPs for the 30-year Treasury rates given above. Because of inflation, he will need substantially higher retirement monthly income to maintain the same purchasing power. He plans to purchase a guaranteed lifetime annuity from a AAA rated insurance company[1]one month before he retires (539 months from now). The retirement annuity will begin in exactly 45 years (540 months).At the time the retirement annuity is purchased, the insurance company will add a 5.00 percent premium to the pure premium cost of the purchase price of the annuity. The pure premium is the actuarial cost of his anticipated lifetime annuity.He has savings of $60,000 today that will be invested at anannual return of 6.00%.Given a rate of return of6.00%for the foreseeable future, how much does he need to save each month (total of 539 payments) until the month before he retires? He will make the first payment next month and the last payment one month before he retires. For life expectancy after retirement, use the Cohort Life Tables for Social Security Area by Sex table below:
Cohort Life Tables for Social Security by Sex
Male
Female
Probability
# of 100,000
Life
Probability
# of 100,000
Life
Age
Death
Living
Expectancy
Age
Death
Living
Expectancy
40
0.00170
96,759
42.94
40
0.00108
98,088
46.22
41
0.00183
96,595
42.01
41
0.00116
97,982
45.27
42
0.00196
96,418
41.09
42
0.00123
97,869
44.33
43
0.00209
96,229
40.17
43
0.00129
97,749
43.38
44
0.00223
96,028
39.25
44
0.00135
97,622
42.43
45
0.00238
95,814
38.33
45
0.00142
97,490
41.49
46
0.00254
95,586
37.43
46
0.00150
97,352
40.55
47
0.00268
95,343
36.52
47
0.00159
97,205
39.61
48
0.00278
95,088
35.62
48
0.00168
97,051
38.67
49
0.00288
94,823
34.71
49
0.00178
96,888
37.74
50
0.00299
94,550
33.81
50
0.00190
96,715
36.80
51
0.00313
94,268
32.91
51
0.00204
96,532
35.87
52
0.00331
93,973
32.01
52
0.00221
96,335
34.94
53
0.00355
93,662
31.12
53
0.00241
96,123
34.02
54
0.00385
93,329
30.23
54
0.00265
95,891
33.10
55
0.00419
92,970
29.34
55
0.00292
95,637
32.19
56
0.00457
92,581
28.46
56
0.00322
95,358
31.28
57
0.00497
92,158
27.59
57
0.00354
95,051
30.38
58
0.00539
91,700
26.73
58
0.00386
94,714
29.49
59
0.00585
91,205
25.87
59
0.00420
94,348
28.60
60
0.00635
90,672
25.02
60
0.00457
93,952
27.72
61
0.00693
90,096
24.18
61
0.00500
93,522
26.84
62
0.00763
89,472
23.34
62
0.00551
93,054
25.97
63
0.00847
88,790
22.52
63
0.00613
92,541
25.12
64
0.00944
88,038
21.70
64
0.00683
91,974
24.27
65
0.01053
87,206
20.91
65
0.00762
91,346
23.43
66
0.01167
86,288
20.12
66
0.00845
90,650
22.61
67
0.01284
85,281
19.36
67
0.00930
89,884
21.80
68
0.01402
84,186
18.60
68
0.01014
89,048
21.00
69
0.01523
83,006
17.86
69
0.01101
88,145
20.21
70
0.01660
81,742
17.13
70
0.01199
87,175
19.42
71
0.01811
80,385
16.41
71
0.01308
86,130
18.65
72
0.01965
78,929
15.70
72
0.01419
85,003
17.89
73
0.02119
77,378
15.01
73
0.01533
83,797
17.15
74
0.02280
75,739
14.32
74
0.01653
82,513
16.40
75
0.02479
74,012
13.64
75
0.01804
81,148
15.67
76
0.02713
72,177
12.98
76
0.01979
79,685
14.95
77
0.02954
70,219
12.32
77
0.02154
78,107
14.24
78
0.03200
68,144
11.68
78
0.02321
76,425
13.54
79
0.03469
65,964
11.05
79
0.02502
74,651
12.85
Expected Inflation =2.22 - 0.57 = 1.65
Expected Remaining Life in Months at Retirement=17.13x12 = 206
Needed per month retirement income.
FV45 years=$8,000 (1.0165)45= $8,000(2.0884892) =$_____16,707_____
Total amount Needed in retirement account one month (month 539) before retirement.
PVAmonth 539=$__________=$_________(__________)=$______________
Premium and price to Insurance Company
Price =$___________(1.050) =$____________
Value of Current Savings in 539 months (assuming monthly compounding.
FV539 months=$60,000 (1._______)539= $60,000 (____________)=$___________
Total New Saving needed by month 539=$_____________
Saving Each month for next 539 Months.
=$_______________
Then,
A =$____________/______________ =$__________ per month
[1]Seehttp://www.ambest.com/home/default.aspxAM Best is the only global credit rating agency with a unique focus on the insurance industry.
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