5. The Bailey Brothers Building and Loan Bank is a financial institution located in Bedford Falls, N.Y. It's balance sheet consists of the following. Assets: $410K of reserves, $1000K of Commercial Loans, $2000K of Mortgages, and $200K of government securities. Liabilities: $3100K of Deposits, $300K loan from Bedford Falls Community Bank. Banks are required to hold 10% of deposits in the form of reserves. Furthermore, banks are required to maintain a risk adjusted capital asset ratio of 10%. The weights for risk adjusted asset value is 1 for commercial loans, .5 for mortgages and zero for reserves and government securities. a. (5 points) Write out Bailey Brother Building and Loan balance sheet (T-account). b. (5 points) What is the amount of bank capital? Does this bank have sufficient capital to satisfy the capital/risk adjusted asset ratio? (show work) c. (5 points) As a result of financial difficulties elsewhere in the banking system, the Bedfords Falls Community Bank calls (demands repayment of) the Bailey Brothers $300K loan. Assume that it is relatively easy to liquidate government securities but much more difficult to liquidate mortgages and commercial loans or to borrow from other financial institutions. What must Bailey Brothers do in response? Show the Bailey Brothers' balance sheet after making the necessary adjustments to satisfy its reserve requirement ratio and its risk adjusted capital/asset ratio. d. (5 points) Depositors seeing bank runs on other financial institutions get nervous and suddenly withdraw $500K in deposits from Bailey Brothers. In order to meet the deposit withdrawal, George and Mary Bailey offer some of their own money as a capital injection to the Bailey Brothers Bank. How large a capital injection must occur so that Bailey Brother can meet the deposit withdrawal and still satisfy the required reserve ratio and the risk adjusted capital/asset ratio? e. (5 points) To make matter worse, interest rates increase 2 percentage points affecting the value of the Bailey Brothers Building and Loan's assets and liabilities. Assume that the duration for reserves and deposits is zero, the duration for commercial loans is five, and the duration for mortgages is 10. What is the approximate decline in Bailey Brothers' assets and liabilities in percentage terms? What does the Bailey's balance sheet look like taking into account the change in asset values? Is it still solvent? Does it meet the required risk adjusted capital/asset ratio? Show work. f. (5 points) Regulators, if they determine that additional capital is needed, approach Mr. Potter (the richest man in town) to inject additional capital into Bailey Building and Loan. How much capital must be injected to meet the risk adjusted capital asset ratio? Show work. 5. The Bailey Brothers Building and Loan Bank is a financial institution located in Bedford Falls, N.Y. It's balance sheet consists of the following. Assets: $410K of reserves, $1000K of Commercial Loans, $2000K of Mortgages, and $200K of government securities. Liabilities: $3100K of Deposits, $300K loan from Bedford Falls Community Bank. Banks are required to hold 10% of deposits in the form of reserves. Furthermore, banks are required to maintain a risk adjusted capital asset ratio of 10%. The weights for risk adjusted asset value is 1 for commercial loans, .5 for mortgages and zero for reserves and government securities. a. (5 points) Write out Bailey Brother Building and Loan balance sheet (T-account). b. (5 points) What is the amount of bank capital? Does this bank have sufficient capital to satisfy the capital/risk adjusted asset ratio? (show work) c. (5 points) As a result of financial difficulties elsewhere in the banking system, the Bedfords Falls Community Bank calls (demands repayment of) the Bailey Brothers $300K loan. Assume that it is relatively easy to liquidate government securities but much more difficult to liquidate mortgages and commercial loans or to borrow from other financial institutions. What must Bailey Brothers do in response? Show the Bailey Brothers' balance sheet after making the necessary adjustments to satisfy its reserve requirement ratio and its risk adjusted capital/asset ratio. d. (5 points) Depositors seeing bank runs on other financial institutions get nervous and suddenly withdraw $500K in deposits from Bailey Brothers. In order to meet the deposit withdrawal, George and Mary Bailey offer some of their own money as a capital injection to the Bailey Brothers Bank. How large a capital injection must occur so that Bailey Brother can meet the deposit withdrawal and still satisfy the required reserve ratio and the risk adjusted capital/asset ratio? e. (5 points) To make matter worse, interest rates increase 2 percentage points affecting the value of the Bailey Brothers Building and Loan's assets and liabilities. Assume that the duration for reserves and deposits is zero, the duration for commercial loans is five, and the duration for mortgages is 10. What is the approximate decline in Bailey Brothers' assets and liabilities in percentage terms? What does the Bailey's balance sheet look like taking into account the change in asset values? Is it still solvent? Does it meet the required risk adjusted capital/asset ratio? Show work. f. (5 points) Regulators, if they determine that additional capital is needed, approach Mr. Potter (the richest man in town) to inject additional capital into Bailey Building and Loan. How much capital must be injected to meet the risk adjusted capital asset ratio? Show work
