4. Bank Leverage (Based on Mankiw Ch. 4 # 9) . Jimmy Paul Miller starts his own bank, called JPM. As owner, Jimmy puts in $2,000 of his own money. JPM then borrows $4,000 in a long-term loan from Jimmy's uncle, accepts $14,000 in demand deposits from his neighbors, buys $7,000 of U.S. Treasury bonds, lends $10,000 to local businesses, and keeps the remainder of the bank's assets as reserves at the Fed. a.) Show JPM's balance sheet. What is JPM's leverage ratio? b.) An economic downturn causes 20 percent of the local businesses to declare bankruptcy and default on their loans. Show JPM's new balance sheet. By what percentage does the value of JPM's assets fall? By what percentage does JPM's capital fall? As a result of the downturn, does it look like JPM will be able to stay in operation? c.) Let's say that prior to the downturn, the government had concerns about the ability of businesses to pay back their loans and put in place a 40% capital requirement. That is, banks had to hold capital equal to 40 % of whatever money they loaned out. Assuming JPM wanted to maintain its volume of lending, show the bank's balance sheet prior to the downturn with the capital requirement. You can assume Jimmy has the means to make further investment in the bank. Also, calculate JPM's new leverage ratio. Is this ratio lower or higher than before? Does this imply JPM is more or less likely to go bankrupt? d.) Show JPM's new balance sheet after the downturn (which still causes 20 percent of businesses to default on their loans) with the capital requirement imposed. By what percentage does the value of JPM's assets fall? By what percentage does JPM's capital fall? As a result of the capital requirement, is JPM more likely to be able to remain in operation after the downturn? e.) Say Jimmy is unwilling to make any further investment in JPM. How does JPM meet its capital requirement in this case? Show JPM's new balance sheet prior to the downturn. What impact would you expect this to have on the money supply? Why? Money Multiplier (Based on Mankiw Ch. 4 #5). Consider an economy with a monetary base of $1,000. People hold a third of their money in the form of currency (and thus two-thirds as bank deposits). Banks hold a third of their deposits in reserves. a.) What is the reserve-deposit ratio, the currency-deposit ratio, the money multiplier, and the money supply? b.) Say a financial crisis takes place which strikes fear in the population about the safety of banks. As a result, people now hold half their money in the form of currency. What is the new money multiplier? Did it rise or fall as a result of people holding more currency? What is the new money supply? c.) If, in the face of this panic, the central bank wants to conduct an open market operation to keep the money supply at its original level, does it buy or sell government bonds? Calculate, in dollars, how much the central bank needs to transact. d.) Say the financial crisis lowered banks' confidence in the public's ability to repay their debts, and as a result they cut back on lending and now hold half of their deposits in reserve. Taking the developments in this part and part b.) into account, what is the new money multiplier? Did it rise or fall as a result of banks holding more reserves? What is the new money supply? e.) Now how much does the central bank need to transact in order to keep the money supply at its original level? Is this more or less than in part d.)? Why? 4. Bank Leverage (Based on Mankiw Ch. 4 # 9) . Jimmy Paul Miller starts his own bank, called JPM. As owner, Jimmy puts in $2,000 of his own money. JPM then borrows $4,000 in a long-term loan from Jimmy's uncle, accepts $14,000 in demand deposits from his neighbors, buys $7,000 of U.S. Treasury bonds, lends $10,000 to local businesses, and keeps the remainder of the bank's assets as reserves at the Fed. a.) Show JPM's balance sheet. What is JPM's leverage ratio? b.) An economic downturn causes 20 percent of the local businesses to declare bankruptcy and default on their loans. Show JPM's new balance sheet. By what percentage does the value of JPM's assets fall? By what percentage does JPM's capital fall? As a result of the downturn, does it look like JPM will be able to stay in operation? c.) Let's say that prior to the downturn, the government had concerns about the ability of businesses to pay back their loans and put in place a 40% capital requirement. That is, banks had to hold capital equal to 40 % of whatever money they loaned out. Assuming JPM wanted to maintain its volume of lending, show the bank's balance sheet prior to the downturn with the capital requirement. You can assume Jimmy has the means to make further investment in the bank. Also, calculate JPM's new leverage ratio. Is this ratio lower or higher than before? Does this imply JPM is more or less likely to go bankrupt? d.) Show JPM's new balance sheet after the downturn (which still causes 20 percent of businesses to default on their loans) with the capital requirement imposed. By what percentage does the value of JPM's assets fall? By what percentage does JPM's capital fall? As a result of the capital requirement, is JPM more likely to be able to remain in operation after the downturn? e.) Say Jimmy is unwilling to make any further investment in JPM. How does JPM meet its capital requirement in this case? Show JPM's new balance sheet prior to the downturn. What impact would you expect this to have on the money supply? Why? Money Multiplier (Based on Mankiw Ch. 4 #5). Consider an economy with a monetary base of $1,000. People hold a third of their money in the form of currency (and thus two-thirds as bank deposits). Banks hold a third of their deposits in reserves. a.) What is the reserve-deposit ratio, the currency-deposit ratio, the money multiplier, and the money supply? b.) Say a financial crisis takes place which strikes fear in the population about the safety of banks. As a result, people now hold half their money in the form of currency. What is the new money multiplier? Did it rise or fall as a result of people holding more currency? What is the new money supply? c.) If, in the face of this panic, the central bank wants to conduct an open market operation to keep the money supply at its original level, does it buy or sell government bonds? Calculate, in dollars, how much the central bank needs to transact. d.) Say the financial crisis lowered banks' confidence in the public's ability to repay their debts, and as a result they cut back on lending and now hold half of their deposits in reserve. Taking the developments in this part and part b.) into account, what is the new money multiplier? Did it rise or fall as a result of banks holding more reserves? What is the new money supply? e.) Now how much does the central bank need to transact in order to keep the money supply at its original level? Is this more or less than in part d.)? Why