Money and Banking Homework #4 Spring 2015 If there is a run on deposits of S50 a
ID: 2758085 • Letter: M
Question
Money and Banking Homework #4 Spring 2015 If there is a run on deposits of S50 and required reserv es arc 10% of deposits what problem is CMC facing? Show-using a separate balance sheet for cach example-4 different ways this problem can be solved. What are the most desirable ways to deal with this problem? The least desirable? If CMC is forced to write down $60 billion in mortgage loans w hat problem arc the facing? Also, show this with a balance sheet. Who will solve this problem? Assume that the Fed has decided to increase reserves in the banking system by $200 billion. Also assume that reserve requirements arc 10% of deposits and assume that banks do not hold excess reserves. Answer the following questions. What happens to the Fed's balance sheet? What happens to the balance sheet of the banking system ? What arc some factors that may make the increase in reserves cause a smaller increase in the money supply? 3. Quantitative Easing 3 (QE3) is the Federal Reserve's latest attempt to push the economic recovery forward. The following questions relate to QE3. a. Show on the Fed's balance sheet one month's open market purchases of $85 billion b.Explanation / Answer
1a. If there is a a reserve of 10% of the deposit, the deposit amount will be = 10% of the amount of deposit on which there is a run = 10% of $50 billion = $5 billion.
Balance amount of deposit = total amount on which there is a run - amount of reserve = 50-5 = $45 billion. The problem that the bank is facing is that of lack of availability of ready reserves to service the run. If the run on deposits gain momentum, the bank can face the risk of being insolvent.
The options are:
(i) raise borrowings of $45 billion to service this defecit. The new balance sheet will see the deposits reducing by $50 on the liabilities side. Borrowings will increase by $45 and on the assets side, reserve will fall by $5.
(ii) 2nd option is to use the entire reserves to service the run on deposit. Both reserves and deposits will fall by $50 in the balance sheet.
(iii) The 3rd option is to sell its securities to pay the balance $45. Securities will fall by $45, and the deposits will fall by $50. Reserves will fall by $5.
500
(iv) the 4th option is to raise more capital (to the tune of $45 to pay off the debt). In this case, the balance sheet will be:
The best option is to raise new capital from shareholders. This option has the minimum risk.Selling its securities will reduce its interest earnings. Fresh borrowings will increase its interest expenses.
The worst option is to use all the reserves. This will make the future very risky as there will be no reserves with the bank.
b. Now, if CMC is forced to write down a $60 billion loan, then the following will happen: loans will reduce by $60 and so will capital. Balance sheet will be:
Thus CMC's net worth has become negative. This makes it insolvent and Fed can liquidate it. It will have to raise fresh capital to cover the write down.
Assets Liabilities Reserves 45 Deposits 450 Loans 400 Bank Capital 50 Securities 100 Borrowing 45 Total 545 Total 545Related Questions
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