Bank B\'s Balance Sheet Assets Liabilities Cash Loan to Bank C 1,000 Deposits 50
ID: 1107523 • Letter: B
Question
Bank B's Balance Sheet Assets Liabilities Cash Loan to Bank C 1,000 Deposits 500 1.400 Total assets Total liabilities Equity (net worth Bank C's Balance Sheet Assets Liabilities Mortgage-backed securities 800 Deposits 200 Loan from bank B500 Total liabilities Equity (net worth Total assets (a) Fill in the missing entries in the balance sheets. (b) What is the leverage ratio in each bank? (c) Suppose housing prices fall sharply and the mortgage-backed securities held by bank C fall in value to only S500. What happens to bank C"'s net worth? What happens to Bank B's net worth?Explanation / Answer
(a)
(1) Bank B
(i) Total assets = Cash + Loan to Bank C = 1,000 + 500 = 1,500
(ii) Total liabilities = Deposit = 1,400
(iii) Equity = Total assets - Total liabilities = 1,500 - 1,400 = 100
(2) Bank C
(i) Total assets = Mortgage backed securities = 800
(ii) Total liabilities = Deposit + Loan from Bank B = 200 + 500 = 700
(iii) Equity = Total assets - Total liabilities = 800 - 700 = 100
(b) Leverage ratio = Equity / Total assets
Bank B: (100 / 1,500) = 0.667 = 6.67%
Bank C: (100 / 800) = 0.125 = 12.5%
(c)
(i) For Bank C,
New total assets = 500
Net worth (Equity) = 500 - 700 = - 200
(ii) For Bank B,
Since Equity becomes negative for Bank C, it will be unable to repay the loan it has taken from Bank B. Therefore, Bank B's total asset will fall by the loss of equity in Bank C, i.e by 200.
New total assets for Bank B = 1,500 - 200 = 1,300
New Equity for Bank B = 1,300 - 1,400 = - 100
Bank B's equity will fall by 200.
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