How the Flow of Funds Affects Bank Performance In recent years, Carson Company h

Question

How the Flow of Funds Affects Bank Performance

In recent years, Carson Company has requested the services listed below from Blazo Financial, a financial conglomerate. These transactions have created a flow of funds between Carson Company and Blazo.

a. Classify each service according to how Blazo benefits from the service.

Advising on possible targets that Carson may acquire

Futures contract transactions

Options contract transactions

Interest rate derivative transactions

Loans

Line of credit

Purchase of short-term CDs

Checking account

b. Explain why Blazo’s performance from providing these services to Carson Company and other firms will decline if economic growth is reduced.

c. Given the potential impact of slow economic growth on a bank’s performance, do you think that commercial banks would prefer that the Fed use a restrictive monetary policy or an expansionary monetary policy?

Explanation / Answer

1

All the services except for the purchase of shortterm CDs may generate fees for Blazo Financial, and therefore generates noninterest income. Second, Blazo incurs an interest expense on the CD, but it channels the funds into loans or investments that pay interest income. Third, Blazo’s loans to Carson Company generate interest income. Fourth, Blazo incurs noninterest expenses from establishing the infrastructure and hiring the employees that can provide all of these services.

2

Economic growth is reduced, the demand for advisory services, because there are less acquisitions. This reduces Blazo Bank’s non-interest income. There are fewer loans because there is expansion by firms. This reduces Blazo’s interest income. There may be more loan defaults.

3

Normally, banks would prefer that the Fed use a loose money policy (assuming that inflation is not out of control).

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