PLEASE PROVIDE SHORT YET UNDERSTANDABLE 2-5 SENTENCE ANSWER THE FOLLOWING QUESTI
ID: 2590493 • Letter: P
Question
PLEASE PROVIDE SHORT YET UNDERSTANDABLE 2-5 SENTENCE ANSWER THE FOLLOWING QUESTIONS
a. Consider a bank that has $5M in equity, and $100M in assets. Draw the bank’s balance sheet and calculate its leverage.
b. Consider a bank that has $10M in equity, and $100M in assets. Draw the bank’s balance sheet and calculate its leverage.
c. Suppose that the value of assets drops by 2%. Calculate the bank’s new level of leverage. How many assets does the bank need to sell in this case to restore its previous level of leverage? From the analysis above, provide a reason why regulators may require banks to hold higher levels of equity.
d, Suppose that the value of assets increases by 2%. Calculate the bank’s new level of leverage. How many assets does the bank need to sell in this case to restore its previous level of leverage? From the analysis above, provide a reason why regulators may require banks to hold lower levels of equity.
Explanation / Answer
A balance sheet is a financial report which includes assets, liabilities and owners equity which is prepared at the end of the accounting period. An asset is anything that a company owns. A liability is an obligation that the company is liable to pay at the end of the period. The equity refers to bank capital or owners capital that is left when assets are sold to cover the liabilities.
Part -1
Balance sheet for the year ended….
Liabilities
Amount
Amount(Millions)
Assets
Amount
Amount (Millions
Equity
5
Assets
100
Other Liabilities
95
Total
100
Total
100
The accounting Equation
Equity + Liabilities = Total Assets.
= 5Million + X = 100 Millions
X= 95 Millions
Calculate Leverage
Leverage ratio is the relationship between a bank’s organization core capital and its total assets of the bank. The leverage ratio can be calculated as
Total Asset/ Total Equity
Financial leverage = 100/5 = 20
The ratio 20 indicates that the major portion of the assets are financed with debt rather than equity.
Part -2
Balance sheet for the year ended….
Liabilities
Amount
Amount(Millions)
Assets
Amount
Amount (Millions
Equity
10
Assets
100
Other Liabilities
90
Total
100
Total
100
Financial Leverage = Total assets/ Total equity
= 100/10 = 10
The ratio 10 indicates that the major portion of the assets are financed with debt rather than equity.
PART -3
If total assets dropped by 2 % the total asset value become 98 M
Banks New level of Leverage = Total assets = 98 and Total Equity = 5
What if equity is 10 M
= 98/10 = 9.8. Previous leverage = 20
2 times
Banks play a central role in financial system of a country. The capital of the company should be large enough to cover all the losses. The economic value of a bank assets should be higher than the liability it pays.
Thank You.. Kindly rate
Liabilities
Amount
Amount(Millions)
Assets
Amount
Amount (Millions
Equity
5
Assets
100
Other Liabilities
95
Total
100
Total
100
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