Consider the following information for the First National Bank (a hypothetical bank). The banks sources of fund include $50 million of bank capital and $150 million of deposits. The banks uses of fund include $15 million of reserves and $185 million of loans. The average interest rate on deposits is 1%, the average interest rate on loans is 5%, the initial interest rate on reserves is 0%, and the business income tax rate is 20%. Draw a T-account for the First National Bank and calculate its rate of return on equity using the information above.

Now suppose the Federal Reserve raises the required reserve ratio from 10% to 20% and raises the interest rate on reserves from 0% to 0.25%. Evaluate alternative strategies for the First National Bank to meet the new required reserve ratio. Suppose that after careful consideration, the First National Bank has ruled out the possibility of borrowing from other banks or from the Federal Reserve. The First National Bank is considering whether it should recall loans or raise new capital by selling its own stocks. Give your advice to the First National Bank on which of the two should be the preferred strategy. To provide your advice, draw a T-account and calculate the implied rate of return on equity for each of the two strategies under consideration (for rate of return on equity, keep three decimal places if rounding is needed; for example, round 0.1051 to 0.105 or round 10.51% to 10.5%). Assume that the First National Bank would raise its reserves to a level just sufficient to meet the new required reserve ratio. If the First National Bank chooses to recall loans, assume that the average interest rate on loans remains unchanged. If the First National Bank chooses to sell its own stocks, assume that the market value of stocks sold would be exactly the same as the new capital raised.