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 an asset management bank but is a liability management bank, where core deposits plus capital are less than demand for loans. Thus your bank needs to acquire money market funds in the Eurodollar 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 a liability management bank.

Demand function for agriculture loans (L_A)

r_A = 13.00% - .0005L_A

L_A=$10,000_r_A= _8.0%__

Demand for function for consumer loans (L_C)

r_C = 9.00% - .0002L_C

L_C=$15,000_r_C= _6.00%_

Supply function for demand deposits (D_D)

r_D = -4.00% + .0004375D_D

D_D= $8,000r_D=-0.50%

Supply function for time deposits (D_T)

r_T = 0.00 + .00015D_T

D_T= $10,000r_T=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 an asset management bank, where you have a problem that demand for assets are greater than supply of deposits plus capital.

Bank of Milan, Tennessee

Statement of Financial Conditions (pro forma)

October 1, 2019

Assuming an Asset Management Bank

U.S. Treasury Securities$0 Demand Deposits $8,000.00_

Agriculture Loans$10.000.00Time Deposits$10,000.00_

Consumer Loans$15,000.00 Capital2,000.00

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 (L_A)

r_A = 13.00% - .0005L_A

L_A=$r_A= ________%

Demand for function for consumer loans (L_C)

r_C = 9.00% - .0002L_C

L_C=$r_C= _________%

Supply function for demand deposits (D_D)

r_D = -4.00% + .0004375D_D

D_D= $________r_D=________%

Supply function for time deposits (D_T)

r_T = 0.00 + .00015D_T

D_T= $_________r_T=________%

Bank of Milan, 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 of Milan, 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______$_________________________________