Question
4. The head of the division mentions that he has to do a presentation about liability and liquidity management to Unibanks board of directors. Therefore,
4. The head of the division mentions that he has to do a presentation about liability and liquidity management to Unibanks board of directors. Therefore, please provide him information about the following issues to assist with his presentation:
a. Distinguish between loan sales with and without recourse. (2 marks)
b. Why would financial institutions want to sell loans with recourse? (2 marks)
c. Explain how loan sales can leave financial institutions exposed to contingent interest rate risks. (2 marks)
d. Briefly explain what a contagious run is, some of the potentially serious adverse social welfare effects of a contagious run and whether all types of financial institutions face the same risk of contagious runs. (4 marks)
e. Calculate the true stockholder net worth based on the following balance sheet value of UniBank in market value terms (in millions of dollars): (2 marks)
Assets | $ | Liabilities and equity | $ |
Cash | 10 | Deposits | 335 |
Liquid assets | 50 | Interbank loan | 5 |
Loans | 320 | Equity | 40 |
Total assets | 380 | Total liabilities and equity | 380 |
In addition, the bank has contingent assets with $50 million market value and contingent liabilities with $60 million market value. |
f. Explain what the term contingent means (2 marks)
g. Why are contingent assets and liabilities like options? (2 marks)
h. What is meant by the term 'notional value' of a contingent liability? (2 marks)
i. Why do over-the-counter contracts carry more contingent credit risk than exchange-traded contracts? (2 marks)
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