1. Two banks have lent $20million each to a country in an Emerging Market. Bank A has total assets of $220 million and a capital to total assets ratio of 7 percent. Bank B has total assets of $350 million and a capital to total assets ratio of 6 percent. Both banks that each of their entire $20 million loan package will be written off as bad loans.
a. Will any of the two banks survive this crisis? Explain carefully.
b. Is the problem one of illiquidity or insolvency? Explain.
2. A bank has issued a one-year certificate of deposit for $50 million at an interest rate of 2 percent. With the proceeds, the bank has purchased a two-year Treasury note that pays 4 percent interest. What risk does the bank face in entering into these transactions? What would happen if all interest rates were to rise by 1 percent?
3. Consider a bank with the following income statement: It has $100 in loans with an interest rate of 5 percent; $50 in security holdings, paying 10 percent; reserves of $10; $100 in savings accounts that earn an interest rate of 2.5 percent; checking deposits equal to $30, a net worth of $30, and other expenses of $15. Find bank profit, the return on equity, and return on assets.
a. What is the total income
b. What is the total expenses
c. What is the bank's profit
d. Find the return on equity
e. Find the return on assets
4. Suppose that a firm a choice of a guaranteed project that will earn it a profit of $20 per $100 invested, and a risky project that will earn it $50 per $100 invested with a 65 percent probability and will earn nothing with a 35 percent probability , If the firm wants to borrow from a bank, what is the lowest amount of collateral that the bank should require to ensure that the firm will choose to proceed with the guaranteed project?
5. You and a friend visit the headquarters of a company and are awestruck by the expensive artwork and designer furniture that graces every office. Your friend is very impressed and encourages you to consider buying stock in the company, arguing that it must be really successful to afford such elegant surroundings. Would you agree with your friend's assessment? What further information (other than the usual financial data) would you obtain before making an investment decision?
6. Suppose two types of firms wish to borrow in the bond market. Firms of type A are in good financial health and are relatively low risk. The appropriate premium over the risk-free rate for lending to these firms is 2%. Firms of type B are in poor financial health and are relatively high risk. The appropriate premium over the risk-free rate for lending to these firms is 6%. As an investor, you have no other information about these firms except that type A and type B firms exist in equal numbers.
a. At what interest rate would you be willing to lend if the risk-free rate were 5%?
b. Would this market function well? What type of asymmetric information problem does this example illustrate? Explain.
7. Discuss at least 4 factors which led to the repeal of the McFadden act.
8. Over time developments in the financial industry had an impact on bank profits. Discuss two factors which led to positive changes and two which led to negative changes.