Chapter 12 Practice Problems

Size: px
Start display at page:

Download "Chapter 12 Practice Problems"

Transcription

1 Chapter 12 Practice Problems 1. Bankers hold more liquid assets than most business firms. Why? The liabilities of business firms (money owed to others) is very rarely callable (meaning that it is required that the business pay its obligation on demand from the creditor). Since their liabilities are not callable, most businesses can afford to invest in assets that are illiquid. Indeed, this is what is known as matching the liquidity of assets and liabilities. Since most business assets are illiquid businesses can afford to hold illiquid assets as well. Historically bank liabilities have been very liquid. Checking accounts are demand deposits meaning that banks are required to pay the value of checking accounts on demand; hence these deposits are as liquid as cash. Because liabilities (plus net worth) must sum to assets, a bank needs to hold liquid assets to meet unexpected withdrawals (reductions in liabilities). Hence, a bank contends with a liquidity mismatch between its assets (low liquidity) and its liabilities (high liquidity). Diminishing this mismatch enables a bank to meet its depositors demands but at a cost (less liquid assets must pay a higher rate of return, ceteris paribus, than highly liquid assets). 2. How do banks minimize liquidity risk? Is there a tradeoff between liquidity risk and interest rate risk? Banks and other depository institutions share liquidity risk because transactions deposits and savings accounts can be withdrawn at any time. Thus when withdrawals signficiantly exceed new deposits over a period, banks must scramble to replace the shortfall in funds. For years bankers solved this liquidity problem by having lots of government bonds on hand that they could easily sell for cash. It is not surprising, therefore, that the ratio of reserves plus securities to total assets is a traditional measure of bank liquidity. Since 1980 this ratio fell by more than half as banks found ways to make their liabilities less liquid (selling negotiable CDs) or through alternative ways of acquiring funds (federal funds loans and repurchase agreements). Interest rate risk occurs as a result of one side of the balance sheet (usually the liability side) being more prone to interest rate changes than the other. In a typical case, an increase in interest rates increases the cost to the bank of holding liabilities while the same increase in interest rates changes the revenues earned from the asset side less (because the asset side tends to have longer term loans with fixed rates). In many cases, interest rate risk and liquidity risk can be mitigated simultaneously so there may not be a tradeoff. For instance, a bank can reduce liquidity risk by holding many securities. If these securities are short-term bills, then the bank will also have little interest rate risk since, when interest rates change, the value of the short-term bills changes by a small amount. So, it is possible to simultaneously reduce liquidity and interest rate risk however this comes at the cost of holding assets (short term bills) that likely pay very little interest to the bank. An alternative strategy would be through proper liability management where the bank buys deposits in the form of less liquid CDs rather than more liquid demand deposits. By doing this, the bank reduces liquidity risk and increases the duration of its liabilities to more closely match the duration of its assets. Again, there is no tradeoff but instead both risks are simultaneously mitigated.

2 3. Using T-accounts, describe what happens when Jane Doe writes a $50 check on her account at the First National Bank to pay her friend John Deer who in turn deposits the check in his account at the Second National Bank. First National Bank Required Reserves -5 Deposits -50 Excess Reserves -45 Second National Bank Required Reserves +5 Deposits +50 Excess Reserves +45 (assuming a required reserve ratio of 10%). Notice, this check does not change the total banking systems level of reserves or deposits. 4. What happens to reserves at the First National Bank if one person withdraws $1,000 of cash and another deposits $500 of cash? First National Bank Required Reserves -50 Deposits -500 Excess Reserves -450 (assuming a required reserve ratio of 10%). 5. The bank you own has the following balance sheet: Reserves $75 m. Deposits $500 m. Loans $525 m. Bank Capital $100 m. If the bank suffers a deposit outflow of $50 m. with a required reserve ratio on deposits of 10%, what actions must you take to keep your bank from failing? Before taking any actions, the bank s balance sheet would be: Reserves $25 m. Deposits $450 m. Loans $525 m. Bank Capital $100 m. If the required reserve ratio is 10%, then this bank is violating its required reserve level by $20 m. The bank can take four basic actions: 1. Borrow $20 m. on the Federal Funds market in which case its balance sheet would be: Reserves $45 m. Deposits $450 m. Loans $525 m. Bank Borrowings $20 m. Bank Capital $100 m.

3 2. Borrow $20 m. from the Federal Reserve Discount Window in which case its balance sheet would be: Reserves $45 m. Deposits $450 m. Loans $525 m. Federal Reserve $20 m. Borrowings Bank Capital $100 m. 3. Sell $20 million of loans (or not renew $20 million of loans that come due at the same time of the deposit outflow. Reserves $45 m. Deposits $450 m. Loans $505 m. Bank Capital $100 m. 4. While none exist on this bank s balance sheets, most banks hold other types of assets (e.g. treasury bills) which could be sold instead of loans. Doing so transforms one type of asset (a treasury bill) into another (reserves). All 4 choices involve a cost. Choices #1 and #2 raise the expenses of the bank and choices #3 and #4 reduce the bank s revenues. 6. If a deposit outflow of $50 m. occurs, which balance sheet would a bank rather have initially, the balance sheet in Problem 5 or the following? Why? Reserves $100 m. Deposits $500 m. Loans $500 m. Bank Capital $100 m. A $50 m. outflow in this bank leads immediately to the position of: Reserves $50 m. Deposits $450 m. Loans $500 m. Bank Capital $100 m. This bank still holds enough reserves to meet the required reserve level and therefore need not adjust its balance sheet any more. While this may appear to be good that it does not have to incur the additional expenses or loss of revenues that the bank in problem #5 did, it must be remembered that this bank also gave up earning interest on its assets prior to this withdrawal (notice, in order to hold a higher amount of reserves the bank in problem #6 held fewer interest bearing loans). Thus, while the surprise withdrawal outflow is painful for the bank of problem #5, it may have earned enough revenue from its increased prior lending that it ends up in a better position than that of bank #6. 7. What is the difference between insolvency and illiquidity? Insolvency occurs when bank assets are less than its liabilities. This is the traditional meaning of being bankrupt; an insolvent bank cannot meet all of its obligations because it does not own enough to do so. An illiquid bank is not insolvent in that an illiquid bank still has a positive net worth (its assets are equal to its liabilities + capital or, in other words, its capital is greater than zero). However, an illiquid bank does not have enough cash on hand to meet immediate depositor withdrawals. An illiquid bank can become liquid through borrowing from other banks

4 (which they are likely to do since the bank has positive net worth and can repay its loans) or through selling its assets. 8. If a bank falls short of its capital requirements, what can it do? It can raise capital through selling new shares of stock, cutting dividend payments (and increasing its retained earnings) or sell assets so the amount of capital relative to assets rises (remember, the capital requirements are stated in terms of a capital-to-asset ratio). In the recent months, the government has been injecting capital into banks by buying preferred stock on those banks (preferred stock are non-voting shares in a company that take precedence over common shares if the company goes bankrupt). 9. Why do banks require firms that it lends to keep compensating balances at the bank? Compensating balances can act as collateral for loans made by banks to those firms. They also help establish long-term customer relationships which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem. Compensating balances help the bank monitor the activities of a borrowing firms so that it can prevent the firm from taking on too much risk, thereby not acting in the interest of the bank. 10. Suppose that you are the manager of a bank whose $100 billion of assets have an average duration of four years and whose $90 billion of liabilities have an average duration of 2.5 years. Conduct a duration analysis for the bank and show what will happen to the net worth of the bank if interest rates rise by 2 percentage points. What actions could you take to reduce the bank s interest rate risk? The assets fall by $8 billion ($ ) and the value of the liabilities rise by $4.5 billion ($ ) so the bank s net worth (capital) is expected to decrease by $3.5 billion. The interest rate risk can be reduced by shortening the maturity of the assets or by lengthening the maturity of the liabilities. Alternatively, you could engage in an interest-rate swap, in which you swap the interest earned on your assets with the interest on another bank s assets that have a duration of 2.5 years. 11. Suppose you are the manager of a bank that has $15 million of fixed rate assets, $30 million of rate sensitive assets, $25 million of fixed rate liabilities and $20 million of ratesensitive liabilities. Conduct a gap analysis for the bank and show what will happen to bank profits if interest rates rise by 5 percentage points. What action could you take to reduce the bank s interest rate risk? This bank s gap is $10 million ($30 rate sensitive assets - $20 rate sensitive liabilities). An increase in interest rates by 5% will raise profits by $500,000 (5% of the gap). While banks enjoy the higher profits, a decrease in interest rates would have reversed the profits into losses of equal amounts. To avoid this profit variability, this bank could have tried to increase the amount of interest rate sensitive liabilities it holds, decrease the rate sensitive assets it holds, or engage in an interest rate swap with another company. 12. A bank has issued a one-year certificate of deposit for $5 million at an interest rate of 2 percent. With the proceeds, the bank has purchased a 2 year discount Treasury note that pays 4 percent. What risk does the bank face in entering into these transactions? At the end of one year, this bank will have to pay the CD holder $5.1 million.

5 At the time of purchase, the bank would have spent $5 million on a two year, 4% treasury bill. The face value of such a bill would be $5 million = (FV)/( ) or $5.408 million. However, this bank needs the money at the end of the first year. Notice, the bank does not know the current interest rate at the end of this year, so lets call it i. At the end of the year, the present value of the treasury bill would be: PV = $5.408/(1+i). Since the bank needs $5.1 million we can solve this to find the interest rate needed to allow the bank to sell the 2 year bill and gain $5.1 million. (5.1 = 5.408/(1+i)) yields an i of.0603 or 6.03%. If interest rates remain below 6.03% at the end of the first year, then this bank can sell the 2 year bill and make the $5.1 million payment. If the rate rises to above 6.03% then if the bank sells the 2 year bill it does not produce enough revenue to make the $5.1 m. payment and must draw down bank capital to do so. The risk the bank faces in this case is interest rate risk; higher rates reduce bank profitability and lower rates increase it. One can see this approximately with duration analysis. The duration of the CD is 1 year and, using Macaulay s formula, the percent change in the value of the CD is equal to the percent change in interest rates times the duration. In this case, a one percentage point increase in the interest rate raises the value of the CD to the bank by 1%. Since the CD s face value is $5 m. each one percentage point increase in interest rates raises the value of the CD by $50,000. The duration of the t-note is 2 years so each one percentage point increase in interest rates reduces the value of the t-note by 2%, or $100,000. Thus, for every one percentage point increase in interest rates, the net worth of the bank falls by $50,000 ($50,000 gain in liabilities less $100,000 loss in assets). A two percent increase in rates (from 4% to 6%) will then decrease bank net worth by $100,000. Notice, when rates are 4 percent on the two year note, the bank expects to earn about $200,000 per year on the note. A rise in rates by 6 percent however, reduces the value of the note by $100,000 per year to the bank and, given the bank also has to pay the CD owner $100,000 at the end of one year, the increase in rates by 2% over that year eliminates the bank s added net worth it expected to get from the t-note had its interest rate remained unchanged. 13. Consider the balance sheets of Banks A and B. Which bank faces the greatest liquidity risk? Why? Bank A Reserves $100 m. Deposits $500 m. Loans $500 m. Bank Capital $100 m. Securities $50 m. Borrowings $50 m. Bank B Reserves $60 m. Deposits $500 m. Loans $540 m. Bank Capital $100 m. Securities $50 m. Borrowings $50 m. Bank B faces higher liquidity risk because a withdrawal of $11.11 m. would eliminate all of its excess reserves and leave it with only required reserves. A withdrawal of any further amounts would then cause the bank to either sell its interest bearing securities and loans or pay interest on

6 borrowings from other banks or the Fed. The level of withdrawals required to put Bank B in a similar position is $55.55 m. 14. Bank Y and Bank Z both have assets of $1 billion. The return on assets for both banks is the same. Bank Y has liabilities of (not counting capital) of $800 m. while Bank Z s are $900 m. In which bank would you prefer to hold an equity stake? Explain. This depends. ROE = ROA EM where EM = /Equity. In the case of Bank Y, the EM is 5 ($1 billion / $200 m.). For bank Z, the EM is 10. Thus, the return on equity for Bank Z is twice that for Bank Y. In other words, for each dollar invested by owners in Bank Z, they expect to earn twice a high of rate of return as those who invested in Bank Y. However, because it holds less capital, Bank Z is more prone to insolvency since losses of $100 m. in its assets would cause this bank to have less assets than liabilities + capital. This answer depends then on my risk-return preferences. If I am less risk averse then Bank Z would be preferable. If I were more risk averse, then Bank Y would look preferable (because it is less likely to fail).

Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS. Peter N. Ireland Department of Economics Boston College. irelandp@bc.edu

Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS. Peter N. Ireland Department of Economics Boston College. irelandp@bc.edu Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS Peter N. Ireland Department of Economics Boston College irelandp@bc.edu http://www2.bc.edu/~irelandp/ec261.html Chapter 9: Banking and the Management

More information

The Bank Balance Sheet

The Bank Balance Sheet Chapter 9 THE BANKING FIRM AND THE MANAGEMENT OF FINANCIAL INSTITUTIONS The Bank Balance Sheet T-account Analysis: Bank Operation Deposit of $100 cash into First National Bank Vault Cash + $100 Checkable

More information

How To Invest In Stocks And Bonds

How To Invest In Stocks And Bonds Review for Exam 1 Instructions: Please read carefully The exam will have 21 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation

More information

Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS. Peter N. Ireland Department of Economics Boston College. irelandp@bc.edu

Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS. Peter N. Ireland Department of Economics Boston College. irelandp@bc.edu Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS Peter N. Ireland Department of Economics Boston College irelandp@bc.edu http://www2.bc.edu/~irelandp/ec261.html Chapter 2: An Overview of the Financial

More information

9. Short-Term Liquidity Analysis. Operating Cash Conversion Cycle

9. Short-Term Liquidity Analysis. Operating Cash Conversion Cycle 9. Short-Term Liquidity Analysis. Operating Cash Conversion Cycle 9.1 Current Assets and 9.1.1 Cash A firm should maintain as little cash as possible, because cash is a nonproductive asset. It earns no

More information

Reference: Gregory Mankiw s Principles of Macroeconomics, 2 nd edition, Chapter 15. The Banking System and the Money Supply

Reference: Gregory Mankiw s Principles of Macroeconomics, 2 nd edition, Chapter 15. The Banking System and the Money Supply Macroeconomics Topic 6: Explain how the Federal Reserve and the banking system create money (i.e., the supply of money) Explain the factors that affect the demand for money. Reference: Gregory Mankiw s

More information

i T-bill (dy) = $10,000 - $9,765 360 = 6.768% $10,000 125

i T-bill (dy) = $10,000 - $9,765 360 = 6.768% $10,000 125 Answers to Chapter 5 Questions 1. First, money market instruments are generally sold in large denominations (often in units of $1 million to $10 million). Most money market participants want or need to

More information

4 Macroeconomics LESSON 4

4 Macroeconomics LESSON 4 4 Macroeconomics LESSN 4 The Federal Reserve System and Its Tools Introduction and Description The focus of this lesson is the Federal Reserve System: how its actions relate to the money creation process

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) When a new depositor opens a checking account at the First National Bank, the bank's

More information

Click Here to Buy the Tutorial

Click Here to Buy the Tutorial FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin-534/fin-534-week-4-quiz-3- str/ For more course tutorials visit www.tutorialoutlet.com Which of the following

More information

EC 341 Monetary and Banking Institutions, Boston University Summer 2, 2012 Homework 3 Due date: Tuesday, July 31, 6:00 PM.

EC 341 Monetary and Banking Institutions, Boston University Summer 2, 2012 Homework 3 Due date: Tuesday, July 31, 6:00 PM. EC 341 Monetary and Banking Institutions, Boston University Summer 2, 2012 Homework 3 Due date: Tuesday, July 31, 6:00 PM. Problem 1 Questions 1, 4, 6, 8, 12, 13, 16, 18, 22, and 23 from Chapter 8. Solutions:

More information

3. If an individual investor buys or sells a currently owned stock through a broker, this is a primary market transaction.

3. If an individual investor buys or sells a currently owned stock through a broker, this is a primary market transaction. Spring 2012 Finance 3130 Sample Exam 1A Questions for Review 1. The form of organization for a business is an important issue, as this decision has very significant effect on the income and wealth of the

More information

Review for Exam 1. Instructions: Please read carefully

Review for Exam 1. Instructions: Please read carefully Review for Exam 1 Instructions: Please read carefully The exam will have 20 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation

More information

Chapter 14. The Money Supply Process

Chapter 14. The Money Supply Process Chapter 14. The Money Supply Process C H A P T E R O B J E C T I V E S By the end of this chapter, students should be able to: 1. Describe who determines the money supply. 2. Explain how the central bank

More information

Ipx!up!hfu!uif Dsfeju!zpv!Eftfswf

Ipx!up!hfu!uif Dsfeju!zpv!Eftfswf Ipx!up!hfu!uif Dsfeju!zpv!Eftfswf Credit is the lifeblood of South Louisiana business, especially for the smaller firm. It helps the small business owner get started, obtain equipment, build inventory,

More information

Rigensis Bank AS Information on the Characteristics of Financial Instruments and the Risks Connected with Financial Instruments

Rigensis Bank AS Information on the Characteristics of Financial Instruments and the Risks Connected with Financial Instruments Rigensis Bank AS Information on the Characteristics of Financial Instruments and the Risks Connected with Financial Instruments Contents 1. Risks connected with the type of financial instrument... 2 Credit

More information

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions

Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Understanding Financial Management: A Practical Guide Guideline Answers to the Concept Check Questions Chapter 6 Working Capital Management Concept Check 6.1 1. What is the meaning of the terms working

More information

CHAPTER 6 ASSET-LIABILITY MANAGEMENT: DETERMINING AND MEASURING INTEREST RATES AND CONTROLLING INTEREST-SENSITIVE AND DURATION GAPS

CHAPTER 6 ASSET-LIABILITY MANAGEMENT: DETERMINING AND MEASURING INTEREST RATES AND CONTROLLING INTEREST-SENSITIVE AND DURATION GAPS CHAPTER 6 ASSET-LIABILITY MANAGEMENT: DETERMINING AND MEASURING INTEREST RATES AND CONTROLLING INTEREST-SENSITIVE AND DURATION GAPS Goals of This Chapter: The purpose of this chapter is to explore the

More information

Review for Exam 1. Instructions: Please read carefully

Review for Exam 1. Instructions: Please read carefully Review for Exam 1 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems covering chapter 1, 2, 3, 4, 14, 16. Questions in the multiple choice section will

More information

FIN 204: Money and Banking Homework #2: Solutions. Due: 8 Apr. 2008, 14:30, Instructor: Petar Stankov

FIN 204: Money and Banking Homework #2: Solutions. Due: 8 Apr. 2008, 14:30, Instructor: Petar Stankov I strongly encourage you to work in groups and discuss your solutions, and only then write them down for me. This will save you time AND will improve your understanding of the subject. I do NOT advise

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The government agency that oversees the banking system and is responsible for the conduct

More information

Chapter 13 Money and Banking

Chapter 13 Money and Banking Chapter 13 Money and Banking Multiple Choice Questions Choose the one alternative that best completes the statement or answers the question. 1. The most important function of money is (a) as a store of

More information

Accounts payable Money which you owe to an individual or business for goods or services that have been received but not yet paid for.

Accounts payable Money which you owe to an individual or business for goods or services that have been received but not yet paid for. A Account A record of a business transaction. A contract arrangement, written or unwritten, to purchase and take delivery with payment to be made later as arranged. Accounts payable Money which you owe

More information

Financial Statements and Ratios: Notes

Financial Statements and Ratios: Notes Financial Statements and Ratios: Notes 1. Uses of the income statement for evaluation Investors use the income statement to help judge their return on investment and creditors (lenders) use it to help

More information

Solutions to Chapter 4. Measuring Corporate Performance

Solutions to Chapter 4. Measuring Corporate Performance Solutions to Chapter 4 Measuring Corporate Performance 1. a. 7,018 Long-term debt ratio 0. 42 7,018 9,724 b. 4,794 7,018 6,178 Total debt ratio 0. 65 27,714 c. 2,566 Times interest earned 3. 75 685 d.

More information

What s on a bank s balance sheet?

What s on a bank s balance sheet? The Capital Markets Initiative January 2014 TO: Interested Parties FROM: David Hollingsworth and Lauren Oppenheimer RE: Capital Requirements and Bank Balance Sheets: Reviewing the Basics What s on a bank

More information

American Options and Callable Bonds

American Options and Callable Bonds American Options and Callable Bonds American Options Valuing an American Call on a Coupon Bond Valuing a Callable Bond Concepts and Buzzwords Interest Rate Sensitivity of a Callable Bond exercise policy

More information

Chapter 2. Practice Problems. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

Chapter 2. Practice Problems. MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. Chapter 2 Practice Problems MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Assume that you borrow $2000 at 10% annual interest to finance a new

More information

Using interest rate swaps to increase commercial loans and fee Income By Chad McKeithen

Using interest rate swaps to increase commercial loans and fee Income By Chad McKeithen Using interest rate swaps to increase commercial loans and fee Income By Chad McKeithen Changing landscape There is a growing dilemma between banks nationwide. Some banks are increasing their commercial

More information

READING 1. The Money Market. Timothy Q. Cook and Robert K. LaRoche

READING 1. The Money Market. Timothy Q. Cook and Robert K. LaRoche READING 1 The Money Market Timothy Q. Cook and Robert K. LaRoche The major purpose of financial markets is to transfer funds from lenders to borrowers. Financial market participants commonly distinguish

More information

Finding the Payment $20,000 = C[1 1 / 1.0066667 48 ] /.0066667 C = $488.26

Finding the Payment $20,000 = C[1 1 / 1.0066667 48 ] /.0066667 C = $488.26 Quick Quiz: Part 2 You know the payment amount for a loan and you want to know how much was borrowed. Do you compute a present value or a future value? You want to receive $5,000 per month in retirement.

More information

Chapter 6 Interest rates and Bond Valuation. 2012 Pearson Prentice Hall. All rights reserved. 4-1

Chapter 6 Interest rates and Bond Valuation. 2012 Pearson Prentice Hall. All rights reserved. 4-1 Chapter 6 Interest rates and Bond Valuation 2012 Pearson Prentice Hall. All rights reserved. 4-1 Interest Rates and Required Returns: Interest Rate Fundamentals The interest rate is usually applied to

More information

The Banking System and the Money Supply. 2003 South-Western/Thomson Learning

The Banking System and the Money Supply. 2003 South-Western/Thomson Learning The Banking System and the Money Supply 2003 South-Western/Thomson Learning What Counts as Money MONEY Anything that is widely accepted as a means of payment What Counts as Money MONEY Anything that is

More information

FNCE 301, Financial Management H Guy Williams, 2006

FNCE 301, Financial Management H Guy Williams, 2006 REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including

More information

Financial Ratio Cheatsheet MyAccountingCourse.com PDF

Financial Ratio Cheatsheet MyAccountingCourse.com PDF Financial Ratio Cheatsheet MyAccountingCourse.com PDF Table of contents Liquidity Ratios Solvency Ratios Efficiency Ratios Profitability Ratios Market Prospect Ratios Coverage Ratios CPA Exam Ratios to

More information

The Repo Market. Outline Repurchase Agreements (Repos) The Repo Market Uses of Repos in Practice

The Repo Market. Outline Repurchase Agreements (Repos) The Repo Market Uses of Repos in Practice The Repo Market Outline and Readings Outline Repurchase Agreements (Repos) The Repo Market Uses of Repos in Practice Buzzwords Repo, Reverse repo, Repo rates, Collateral, Margin, Haircut, Matched book,

More information

Describe the functions of the Federal Reserve System (the Fed).

Describe the functions of the Federal Reserve System (the Fed). The Monetary System Chapter CHAPTER CHECKLIST Define money and describe its functions. Money is any commodity or token that is generally accepted as a means of payment. Money serves as a medium of exchange,

More information

Chapter 13 Money and Banking

Chapter 13 Money and Banking Chapter 13 Money and Banking After reading Chapter 13, MONEY AND BANKING, you should be able to: Explain the three functions of money: Medium of Exchange, Unit of Account, Store of Value. Understand the

More information

Infrastructure Finance Prof. A. Thillai Rajan Department of Management Studies Indian Institute of Technology, Madras

Infrastructure Finance Prof. A. Thillai Rajan Department of Management Studies Indian Institute of Technology, Madras Infrastructure Finance Prof. A. Thillai Rajan Department of Management Studies Indian Institute of Technology, Madras Lecture - 6 Basic Financial Management - Part IV Hi welcome back to this course on

More information

Having cash on hand is costly since you either have to raise money initially (for example, by borrowing from a bank) or, if you retain cash out of

Having cash on hand is costly since you either have to raise money initially (for example, by borrowing from a bank) or, if you retain cash out of 1 Working capital refers to liquid funds used to purchase materials and pay workers. This is in contrast to long term capital such as buildings and machinery. Part of working capital management is cash

More information

1. State and explain two reasons why short-maturity loans are safer (meaning lower credit risk) to the lender than long-maturity loans (10 points).

1. State and explain two reasons why short-maturity loans are safer (meaning lower credit risk) to the lender than long-maturity loans (10 points). Boston College, MF 820 Professor Strahan Midterm Exam, Fall 2010 1. State and explain two reasons why short-maturity loans are safer (meaning lower credit risk) to the lender than long-maturity loans (10

More information

I. Introduction. II. Financial Markets (Direct Finance) A. How the Financial Market Works. B. The Debt Market (Bond Market)

I. Introduction. II. Financial Markets (Direct Finance) A. How the Financial Market Works. B. The Debt Market (Bond Market) University of California, Merced EC 121-Money and Banking Chapter 2 Lecture otes Professor Jason Lee I. Introduction In economics, investment is defined as an increase in the capital stock. This is important

More information

Currency: The paper money and coins owned by people and business firms

Currency: The paper money and coins owned by people and business firms WHAT IS MONEY? Things acceptable as a means of payment 2 TYPES OF MONEY 1. COMMODITY MONIES: 2. FIAT MONIES (TOKEN MONIES): DECREED BY THE GOV T AS LEGAL TENDER. The gov t promises the public that will

More information

Duration Gap Analysis

Duration Gap Analysis appendix 1 to chapter 9 Duration Gap Analysis An alternative method for measuring interest-rate risk, called duration gap analysis, examines the sensitivity of the market value of the financial institution

More information

Financial-Institutions Management. Solutions 1. 6. A financial institution has the following market value balance sheet structure:

Financial-Institutions Management. Solutions 1. 6. A financial institution has the following market value balance sheet structure: FIN 683 Professor Robert Hauswald Financial-Institutions Management Kogod School of Business, AU Solutions 1 Chapter 7: Bank Risks - Interest Rate Risks 6. A financial institution has the following market

More information

Fixed Income Portfolio Management. Interest rate sensitivity, duration, and convexity

Fixed Income Portfolio Management. Interest rate sensitivity, duration, and convexity Fixed Income ortfolio Management Interest rate sensitivity, duration, and convexity assive bond portfolio management Active bond portfolio management Interest rate swaps 1 Interest rate sensitivity, duration,

More information

Topics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk

Topics in Chapter. Key features of bonds Bond valuation Measuring yield Assessing risk Bond Valuation 1 Topics in Chapter Key features of bonds Bond valuation Measuring yield Assessing risk 2 Determinants of Intrinsic Value: The Cost of Debt Net operating profit after taxes Free cash flow

More information

How to Assess Your Financial Planning and Loan Proposals By BizMove Management Training Institute

How to Assess Your Financial Planning and Loan Proposals By BizMove Management Training Institute How to Assess Your Financial Planning and Loan Proposals By BizMove Management Training Institute Other free books by BizMove that may interest you: Free starting a business books Free management skills

More information

STATEMENT OF CASH FLOWS AND WORKING CAPITAL ANALYSIS

STATEMENT OF CASH FLOWS AND WORKING CAPITAL ANALYSIS C H A P T E R 1 0 STATEMENT OF CASH FLOWS AND WORKING CAPITAL ANALYSIS I N T R O D U C T I O N Historically, profit-oriented businesses have used the accrual basis of accounting in which the income statement,

More information

Margin Trading. A. How Margin Works? B. Why Trading on Margin Can Be Very Risky and Is Not Suitable for Everyone? C. Conclusion

Margin Trading. A. How Margin Works? B. Why Trading on Margin Can Be Very Risky and Is Not Suitable for Everyone? C. Conclusion A. How Margin Works? B. Why Trading on Margin Can Be Very Risky and Is Not Suitable for Everyone? C. Conclusion 2 An investor who purchases securities may pay for the securities in full, from his own resources,

More information

Simple Interest. and Simple Discount

Simple Interest. and Simple Discount CHAPTER 1 Simple Interest and Simple Discount Learning Objectives Money is invested or borrowed in thousands of transactions every day. When an investment is cashed in or when borrowed money is repaid,

More information

http://angel.bfwpub.com/section/content/default.asp?wci=pgt...

http://angel.bfwpub.com/section/content/default.asp?wci=pgt... Hmwk 14 1. Let's find out what counts as money. In this chapter, we used a typical definition of money: A widely accepted means of payment. Under this definition, which people are using money in the following

More information

Web. Chapter FINANCIAL INSTITUTIONS AND MARKETS

Web. Chapter FINANCIAL INSTITUTIONS AND MARKETS FINANCIAL INSTITUTIONS AND MARKETS T Chapter Summary Chapter Web he Web Chapter provides an overview of the various financial institutions and markets that serve managers of firms and investors who invest

More information

CHAPTER 8 STOCK VALUATION

CHAPTER 8 STOCK VALUATION CHAPTER 8 STOCK VALUATION Answers to Concepts Review and Critical Thinking Questions 5. The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred.

More information

Chapter 6. Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams

Chapter 6. Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams Chapter 6 Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams 1. Distinguish between an ordinary annuity and an annuity due, and calculate present

More information

CHAPTER 26. Working Capital Management. Chapter Synopsis

CHAPTER 26. Working Capital Management. Chapter Synopsis CHAPTER 26 Working Capital Management Chapter Synopsis 26.1 Overview of Working Capital Any reduction in working capital requirements generates a positive free cash flow that the firm can distribute immediately

More information

GUIDE TO THE SURVEY FINANCIAL BALANCE STATISTICS

GUIDE TO THE SURVEY FINANCIAL BALANCE STATISTICS 1(16) GUIDE TO THE SURVEY FINANCIAL BALANCE STATISTICS 1 GENERAL INFORMATION... 3 2 DEFINITION OF DATA... 3 2.1 Positions... 3 2.2... 3 2.3... 4 3 DEFINITION OF VARIABLES... 4 3.1 Financial assets... 4

More information

So You Want to Borrow Money to Start a Business?

So You Want to Borrow Money to Start a Business? So You Want to Borrow Money to Start a Business? M any small business owners cannot understand why a lending institution would refuse to lend them money. Others have no trouble getting money, but they

More information

SMALL BUSINESS DEVELOPMENT CENTER RM. 032

SMALL BUSINESS DEVELOPMENT CENTER RM. 032 SMALL BUSINESS DEVELOPMENT CENTER RM. 032 FINANCING THROUGH COMMERCIAL BANKS Revised January, 2013 Adapted from: National Federation of Independent Business report Steps to Small Business Financing Jeffrey

More information

Loan Disclosure Statement

Loan Disclosure Statement ab Loan Disclosure Statement Risk Factors You Should Consider Before Using Margin or Other Loans Secured by Your Securities Accounts This brochure is only a summary of certain risk factors you should consider

More information

Managing Your Money. a haircut. With $110 to spend, Sandra wrote seven checks totaling $90.

Managing Your Money. a haircut. With $110 to spend, Sandra wrote seven checks totaling $90. Managing Your Money C H A P T E R 6 a haircut. With $110 to spend, Sandra wrote seven checks totaling $90. Unfortunately for Sandra, she made a math error in entering one of her checks into her checkbook

More information

Cash Flow. Summary. Cash Flow. Louise Söderberg, 2010-10-15

Cash Flow. Summary. Cash Flow. Louise Söderberg, 2010-10-15 Cash Flow Louise Söderberg, 2010-10-15 Summary The statement of cash flow reports the cash generated and used during the time interval specified in its headings. A cash flow analysis is a method of checking

More information

Assumptions: No transaction cost, same rate for borrowing/lending, no default/counterparty risk

Assumptions: No transaction cost, same rate for borrowing/lending, no default/counterparty risk Derivatives Why? Allow easier methods to short sell a stock without a broker lending it. Facilitates hedging easily Allows the ability to take long/short position on less available commodities (Rice, Cotton,

More information

Return on Equity has three ratio components. The three ratios that make up Return on Equity are:

Return on Equity has three ratio components. The three ratios that make up Return on Equity are: Evaluating Financial Performance Chapter 1 Return on Equity Why Use Ratios? It has been said that you must measure what you expect to manage and accomplish. Without measurement, you have no reference to

More information

A) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2%

A) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2% 1 Exam FM Questions Practice Exam 1 1. Consider the following yield curve: Year Spot Rate 1 5.5% 2 5.0% 3 5.0% 4 4.5% 5 4.0% Find the four year forward rate. A) 1.8% B) 1.9% C) 2.0% D) 2.1% E) 2.2% 2.

More information

How To Calculate Financial Leverage Ratio

How To Calculate Financial Leverage Ratio What Do Short-Term Liquidity Ratios Measure? What Is Working Capital? HOCK international - 2004 1 HOCK international - 2004 2 How Is the Current Ratio Calculated? How Is the Quick Ratio Calculated? HOCK

More information

Financial Status, Operating Results and Risk Management

Financial Status, Operating Results and Risk Management Financial Status, Operating Results and Risk Management 87 Financial Status 88 89 90 90 90 95 95 Operating Results Cash Flow Effects of Major Capital Expenditures in the Most Recent Fiscal Year on Financial

More information

PROFESSIONAL FIXED-INCOME MANAGEMENT

PROFESSIONAL FIXED-INCOME MANAGEMENT MARCH 2014 PROFESSIONAL FIXED-INCOME MANAGEMENT A Strategy for Changing Markets EXECUTIVE SUMMARY The bond market has evolved in the past 30 years and become increasingly complex and volatile. Many investors

More information

Money Supply. Key point: if banks hold 100% reserves (i.e., make no loans), they do not change the money supply. 1. Who affects the money supply?

Money Supply. Key point: if banks hold 100% reserves (i.e., make no loans), they do not change the money supply. 1. Who affects the money supply? Money Supply 1. Who affects the money supply? 2. 100% reserve banking 3. Fractional reserve banking 4. Money Supply determination and the money multiplier 5. What causes money supply to change? 6. Instruments

More information

Financial ratio analysis

Financial ratio analysis Financial ratio analysis A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction 2. Liquidity ratios 3. Profitability ratios and activity ratios 4. Financial leverage ratios 5. Shareholder

More information

Chapter 9 Solutions to Problems

Chapter 9 Solutions to Problems Chapter 9 Solutions to Problems 1. a. Cash and cash equivalents are cash in hand and in banks, plus money market securities with maturities of 90 days or less. Accounts receivable are claims on customers

More information

Investing Offers Rewards And Poses Risks. Investment Basics: The Power of Compounding. How Do Americans Invest Their Savings? (HA)

Investing Offers Rewards And Poses Risks. Investment Basics: The Power of Compounding. How Do Americans Invest Their Savings? (HA) How Do Americans Invest Their Savings? (HA) Learning how to save money for future use is an important first step in reaching your long-term goals. But saving alone is not enough. You will also need to

More information

Investments GUIDE TO FUND RISKS

Investments GUIDE TO FUND RISKS Investments GUIDE TO FUND RISKS CONTENTS Making sense of risk 3 General risks 5 Fund specific risks 6 Useful definitions 9 2 MAKING SENSE OF RISK Understanding all the risks involved when selecting an

More information

THE STOCK MARKET GAME GLOSSARY

THE STOCK MARKET GAME GLOSSARY THE STOCK MARKET GAME GLOSSARY Accounting: A method of recording a company s financial activity and arranging the information in reports that make the information understandable. Accounts payable: The

More information

Understanding A Firm s Financial Statements

Understanding A Firm s Financial Statements CHAPTER OUTLINE Spotlight: J&S Construction Company (http://www.jsconstruction.com) 1 The Lemonade Kids Financial statement (accounting statements) reports of a firm s financial performance and resources,

More information

Liquidity and Funding Resources

Liquidity and Funding Resources 112 Allianz Group Annual Report Liquidity and Funding Resources Organization The liquidity management of the Allianz Group is based on policies and guidelines approved by the Board of Management of Allianz

More information

A guide to margin borrowing

A guide to margin borrowing A guide to margin borrowing Before you borrow on margin, it is important to review your financial situation, investment objectives, risk tolerance, time horizon, diversification needs, and liquidity objectives

More information

THE MEANING OF MONEY. The Functions of Money. Money has three functions in the economy: The Functions of Money. The Functions of Money

THE MEANING OF MONEY. The Functions of Money. Money has three functions in the economy: The Functions of Money. The Functions of Money In this chapter, look for the answers to these questions: What assets are considered money? What are the functions of money? The types of money? 11 What is the Federal Reserve? What role do banks play

More information

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. ECON 4110: Sample Exam Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Economists define risk as A) the difference between the return on common

More information

U.S. Treasury Securities

U.S. Treasury Securities U.S. Treasury Securities U.S. Treasury Securities 4.6 Nonmarketable To help finance its operations, the U.S. government from time to time borrows money by selling investors a variety of debt securities

More information

Chapter 8. Step 2: Find prices of the bonds today: n i PV FV PMT Result Coupon = 4% 29.5 5? 100 4 84.74 Zero coupon 29.5 5? 100 0 23.

Chapter 8. Step 2: Find prices of the bonds today: n i PV FV PMT Result Coupon = 4% 29.5 5? 100 4 84.74 Zero coupon 29.5 5? 100 0 23. Chapter 8 Bond Valuation with a Flat Term Structure 1. Suppose you want to know the price of a 10-year 7% coupon Treasury bond that pays interest annually. a. You have been told that the yield to maturity

More information

Assurance and accounting A Guide to Financial Instruments for Private

Assurance and accounting A Guide to Financial Instruments for Private june 2011 www.bdo.ca Assurance and accounting A Guide to Financial Instruments for Private Enterprises and Private Sector t-for-profit Organizations For many entities adopting the Accounting Standards

More information

Part 9. The Basics of Corporate Finance

Part 9. The Basics of Corporate Finance Part 9. The Basics of Corporate Finance The essence of business is to raise money from investors to fund projects that will return more money to the investors. To do this, there are three financial questions

More information

Save and Invest Bonds

Save and Invest Bonds Lesson 6 Save and Invest Bonds Lesson Description In this lesson, students will learn that bonds are financial assets used to build wealth. Using the more familiar concept of bank loans, bonds are introduced

More information

INVESTMENT DICTIONARY

INVESTMENT DICTIONARY INVESTMENT DICTIONARY Annual Report An annual report is a document that offers information about the company s activities and operations and contains financial details, cash flow statement, profit and

More information

Synthesis of Financial Planning

Synthesis of Financial Planning P 7A R T Synthesis of Financial Planning 1. Tools for Financial Planning Budgeting (Chapter 2) Planned Savings (Chapter 3) Tax Planning (Chapter 4) 2. Managing Your Liquidity Bank Services (Chapter 5)

More information

Chapter 17. Financial Management and Institutions

Chapter 17. Financial Management and Institutions Chapter 17 Financial Management and Institutions 1 2 3 4 Identify the functions performed by a firm s financial managers. Describe the characteristics and functions of money. Identify the various measures

More information

FIN 684 Fixed-Income Analysis From Repos to Monetary Policy. Funding Positions

FIN 684 Fixed-Income Analysis From Repos to Monetary Policy. Funding Positions FIN 684 Fixed-Income Analysis From Repos to Monetary Policy Professor Robert B.H. Hauswald Kogod School of Business, AU Funding Positions Short-term funding: repos and money markets funding trading positions

More information

Chapter 2 Present Value

Chapter 2 Present Value Chapter 2 Present Value Road Map Part A Introduction to finance. Financial decisions and financial markets. Present value. Part B Valuation of assets, given discount rates. Part C Determination of risk-adjusted

More information

Practice Problems on Money and Monetary Policy

Practice Problems on Money and Monetary Policy Practice Problems on Money and Monetary Policy 1- Define money. How does the economist s use of this term differ from its everyday meaning? Money is the economist s term for assets that can be used in

More information

Using Accounts to Interpret Performance

Using Accounts to Interpret Performance Using s to Interpret Performance ing information is used by stakeholders to judge the performance and efficiency of a business Different stakeholders will look for different things: STAKEHOLDER Shareholders

More information

Chris Leung, Ph.D., CFA, FRM

Chris Leung, Ph.D., CFA, FRM FNE 215 Financial Planning Chris Leung, Ph.D., CFA, FRM Email: chleung@chuhai.edu.hk Chapter 2 Planning with Personal Financial Statements Chapter Objectives Explain how to create your personal cash flow

More information

Chapter 11 The Central Bank Balance Sheet and the Money Supply Process

Chapter 11 The Central Bank Balance Sheet and the Money Supply Process Chapter 11 The Central Bank Balance Sheet Problems and Solutions 1. In an effort to diversify, the Central Bank of China has decided to exchange some of its dollar reserves for euros. Follow the impact

More information

FIN 683 Financial Institutions Management Interest-Rate Risk

FIN 683 Financial Institutions Management Interest-Rate Risk FIN 683 Financial Institutions Management Interest-Rate Risk Professor Robert B.H. Hauswald Kogod School of Business, AU Interest Rate Risk FIs (financial institutions or intermediaries) face two core

More information

Answers to Review Questions

Answers to Review Questions Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual

More information

how to prepare a cash flow statement

how to prepare a cash flow statement business builder 4 how to prepare a cash flow statement zions business resource center zions business resource center 2 how to prepare a cash flow statement A cash flow statement is important to your business

More information

Corporate Credit Analysis. Arnold Ziegel Mountain Mentors Associates

Corporate Credit Analysis. Arnold Ziegel Mountain Mentors Associates Corporate Credit Analysis Arnold Ziegel Mountain Mentors Associates I. Introduction The Goals and Nature of Credit Analysis II. Capital Structure and the Suppliers of Capital January, 2008 2008 Arnold

More information

Public Employees Individual Retirement Account Fund/Deferred Compensation Plan (A Component Unit of the State of Alabama)

Public Employees Individual Retirement Account Fund/Deferred Compensation Plan (A Component Unit of the State of Alabama) Public Employees Individual Retirement Account Fund/Deferred Compensation Plan (A Component Unit of the State of Alabama) FINANCIAL STATEMENTS For the Fiscal Year Ended September 30, 2014 201 South Union

More information