Bank Sim Exam #2 Review

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Northwood University, Michigan *

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Jan 9, 2024

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Piper Barnhart Exam #2- Ch. 11,13,7,2,3,4 40 Qs 30 Qs from 11,13,7 (20 Quantitative, 10 Qs per each ch.) 10 Qs from 2,3, and 4 20 quantitative 20 qualitative 1.) Be familiar with what liquidity means in a banking sense Liquidity- A measure of the cash and other assets banks have available to quickly pay bills and meet short-term business and financial obligations. Ex: central bank reserves and government bonds Liquidity : A financial firm is “liquid” if it has ready access to immediately spendable funds at reasonable cost at precisely the time those funds are needed -This means a liquid firm either has a. The right amount of immediately spendable funds on hand when they are required b. They can raise liquid funds in a timely fashion by borrowing or selling assets -Lack of liquidity can be one of the first signs that a financial institution is in trouble. A firm can be closed if it cannot raise sufficient liquidity even though it may be solvent Demands for liquidity - Customer deposit withdrawals - Credit requests from quality loan customers - Repayment of non-deposit borrowings - Operating expenses and taxes

- Payment of stockholder dividends Supplies of Liquid Funds - Incoming customer deposits - Revenues from the sale of non-deposit services - Customer loan repayments - Sales of bank assets - Borrowings from the money market Liquidity deficit is Lt<0 and Liquidity surplus is Lt>0 Rarely are demands for liquidity equal to the supply of liquidity at any particular moment in time Capital- A measure of the resources banks have to absorb losses. Capital is the difference between all of a firm’s assets and its liabilities. Ex: assets (cash, government securities, and interest-earning loans) like mortgages, letters of credit, and inter-bank loans, minus, liabilities like loan-loss reserves and any debt it owes. - A bank’s capital can be thought of as the margin to which creditors are covered if the bank would liquidate its assets. -Capital: Long-term funds contributed to a bank or other financial institution primarily by its owners consisting mainly of stock, reserves, and retained earnings 2.) Be able to calculate a bank’s net liquidity position

3.) There is a trade of if you want to be well-capitalized or liquid, what do you give up? What is the relationship? - There is a trade-off between liquidity and profitability - The more resources are tied up in readiness to meet demands for liquidity, the lower is that financial firm’s expected profitability (only if other factors are held constant) 4.) Be able to calculate a bank’s expected liquidity deficit or surplus - Liquidity deficit is Lt<0 and Liquidity surplus is Lt>0 5.) Be familiar with sources of liquidity for a bank - Incoming customer deposits - Revenues from the sale of non-deposit services - Customer loan repayments - Sales of bank assets - Borrowings from the money market 6.) Understand the difference between a positive and negative liquidity gap Liquidity gap: the amount by which the sources and uses of liquidity do not match - A negative gap is a term used to describe a situation in which a bank’s interest- sensitive liabilities exceed its interest-sensitive assets - A positive gap occurs when a bank’s assets exceed its liabilities 7.) Understand the difference between a liquidity deficit and a liquidity surplus

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- Liquidity deficit is Lt<0 and Liquidity surplus is Lt>0 8.) Calculate the net liquidity position of a bank 9.) Calculate whether or not a bank has a liquidity deficit, surplus, or if it is balanced (quantitative) 10.) Understand what a bank’s interest sensitive gap is - The interest sensitivity gap was one of the first techniques used in asset liability management to manage interest rate risk. - One of the most popular hedging strategies, Interest Sensitive Gap Management : Gap management techniques requires management to perform an analysis of the maturities and repricing opportunities associated with interest-bearing assets and with interest- bearing liabilities. - A financial firm can hedge itself against interest rate changes by making sure each time period that the Dollar amount of repriceable (interest-sensitive) asset = Dollar amount of repriceable (interest-sensitive) liabilities 11.) Understand the difference between being asset sensitive and liability sensitive Asset sensitive: if interest-assets exceed the volume of interest-sensitive liabilities subject to repricing, the financial firm is said to have a positive gap and be asset sensitive Liability Sensitive: when an interest-sensitive bank’s liabilities are larger than its interest- sensitive assets

-Repriceable Assets: loans that are about to mature or will soon come up for renewal or repricing, such as variable rate business and household loans -Repriceable Liabilities: A depository institutions certificates of deposit (CDs) about to mature or eligible to be renewed. Also includes floating-rate deposits whose yields move up or down with market interest rates. 12.) Understand the difference between a positive and a negative interest sensitive gap A bank with interest-sensitive liabilities below its interest- sensitive assets is: - Asset Sensitive - Positive Interest GAP A bank with interest-sensitive liabilities exceeding its interest-sensitive assets is: - Liability Sensitive - Negative Interest GAP 13.) Understand what impacts Net Interest Margin The net interest margin is influenced by multiple factors: a. Changes in the level of interest rates b. Changes in the spread between asset yields and liability costs c. Changes in the volume of interest-bearing (earning) assets a financial institution holds as it expands or shrinks the overall scale of its activities d. Changes in the volume of interest-bearing liabilities that are used to fund earning assets as a financial institution grows or shrinks in size e. Changes in the mix of assets and liabilities that management draws upon as it shifts between floating and fixed-rate assets and liabilities, between shorter and longer maturity assets and liabilities, and between assets bearing higher versus lower expected yields 14.) Be able to calculate Net Interest Margin

15.) Be able to calculate a bank’s interest sensitive gap - Interest-sensitive assets minus interest- sensitive liabilities 16.) If I were to give you changes can you calculate a new net interest margin? 17.) Using the formula for Net Interest Margin, could you solve for any of the inputs (interest revenue, interest expense, ect.) ? 18.) Calculate the interest sensitive gap of a bank Ex: Dollar IS GAP a. If interest-sensitive assets (ISA) are $150 million and interest-sensitive liabilities (ISL) are $200 million b. The Dollar IS GAP = ISA – ISL = $150 million – $200 million = -$50 million c. An institution whose Dollar IS GAP is positive is asset sensitive, while a negative Dollar IS GAP describes a liability-sensitive condition

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19.) Calculate Net Interest Margin Pg. 227- sensitivity ratios 20.) Understand the customer relationship doctrine - The customer relationship doctrine is a management strategy who’s first priority is making loans to all those customers who meet the lenders quality standards and from whom positive earnings are expected 21.) If I were to give you forecasts of loan and deposit growth, could you calculate the estimated funds gap? Simplified: current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)

22.) Can you calculate the effective costs (rate) of borrowing via CDs (If I said were going to raise 10$ million with an interest rate, but only lend out $9 million, what is interest expense?) - Effective annual interest rate = (1 + (nominal rate / number of compounding periods)) ^ (number of compounding periods) - 1 23.) If I give you the forecasted change in loans, deposits, etc.., can you calculate the estimated funds gap? 24.) If you were to borrow via repos, can you calculate your total interest cost? (when we are calculating we do not divide annual interest rate by 365, divide it by 360!) 25.) Can you calculate the total amount due at the maturity of a CD? 26.) Be able to calculate the effective rate on commercial paper? 27.) Calculate the estimated funds gap.

28.) Calculate the total amount due to a customer on the maturity of their CD 29.) Non-deposit sources of borrowing 30.) Understand why banks are so heavily regulated Pg 30 - Protect safety of publics savings - Control supply of money and credit to achieve a nation's broad economic goals - Ensure equal opportunity in the public's access to credit and other fin services - Promote confidence in financial system, savings safe, savins turn into investments smoothly, payments made smoothly - Avoid few institutions from controlling the money supply - Provide gov with credit, tax rev, ect. 31.) Understand the act that prohibits commercial banks from offering investment banking services Glass Steagall!: The Glass- Steagall legislation describes four provisions of the United States Banking Act of 1933 separating commercial and investment banking. The article 1933 Banking Act describes the entire law, including the legislative history of the provisions covered herein. - Broke down wall between commercial banking and investment banking side, important because it caused the great recession to be such a big deal, commercial banks making bad loans undermined the economy Pg. 33 32.) Understand the effect if the fed intervenes in the market

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- if fed was trying to promote economic activity, now they have lots of securities, they will sell securities they hold- fed goes out to market to sell them- now prices will be lowered -quantative easing: A monetary policy action where a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity 33.) Understand when the Fed buys and sells securities - what does it do to prices and interest rates!? -pg 55 -Sell securities to decrease growth of deposits and loans -purchase securities tends to increase the growth of deposits and loans 33.) Trends in banking industry? (big, medium, small, banks) Understand what’s happening with concentration of banks deposits: -who holds majority? -big banks -however, more small banks than big banks -deposits are flowing to big banks because as time goes on it doesn't matter if location is close, you can bank online -number of banks going down, mergers and acquisitions, more deposits flowing to big bank 34.) Understand the advantages and disadvantages of branch banking and unit banking Unit Banking Branch Banking - One bank, smaller - Usually independent - Caters to community - Affected by local community ups and downs - More than one office, stemming off of larger company - Not as/ or at all effected by local community economy - Less independent

- More independent - Limited financial recourses - Rate of interest less fixed - Can have own policies - Quick decision making, don’t have to get decisions approved by central bank - Many financial resources - Rate of interest fixed completely by head/central bank - Slower decision making, rely on central bank to approve - Cheaper to establish 35.) Understand the advantages and disadvantages of virtual banking 36.) Understand where most new bank charters tend to be located 37.) Understand who can issue bank charters?  State banking commission: STATE -regulatory director that oversees all of the banks in a state. In addition to enforcing regulations and leading investigations into wrongdoing, the commissioner of banking supervises the liquidation of insolvent banks and performs other administrative functions.  OCC: FEDERAL - charters, regulates, and supervises all national banks and federal savings associations as well as federal branches and agencies of foreign banks. The OCC is an independent bureau of the U.S. Department of the Treasury. IMPORTANT TO NOTE: - You want no interest sensitive gap

- Fed leans cheap funds to banks, encourages them to lend money, businesses/individual more apt to borrow money, promotes lending Kahoot 1.) Fed funds sold, maturing CDs, and deposits are examples of Liquidity 2.) If a bank expects $15M in deposit growth and $20M in loan growth, what is it’s liquidity gap? Negative 3.) If a bank’s liquidity position is improving, what is likely happening to its profitability? Deproving 4.) Interest-sensitive assets minus interest- sensitive liabilities is: IS Gap 5.) A bank with interest-sensitive liabilities exceeding its interest-sensitive assets is: Liability Sensitive Negative Interest GAP 6.) Interest income minus interest expenses divided by interest earning assets is: NIM 7.) The Federal Reserve sells $1B in Treasury Bills in the open market. This will tend to: Decrease the price of Treasury Bills Increase market interest rates 8.) Accepting deposits and making loans from various locations is an example of: Branch Bank 9.) An advantage of Unit Banking is:

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More control 10.) Who can issue a new bank charter? OCC State Banking Commission Kahoot Alternatives 1.) If a bank’s liquidity position is deproving, what is likely happening to its profitability? Improving 2.) A bank with interest-sensitive liabilities below its interest- sensitive assets is: Asset Sensitive Positive Interest GAP 3.) Bank Holding Company? A company that controls one or more banks, but does not necessarily engage in banking itself. 4.) Which are not advantages of unit banking? Decreased Chance of Failure Increased Availability and convenience of services Reduced Transaction Costs 5.) Who can not issue a new bank charter? FDIC CFPB Practice Test- Piper 1.) Suppose a bank promises an annual return of 6.5 percent on a three month (90-day $150,00 CD), what will be the total amount due to the customer at the end of the three month period?

- Principal + Interest - = $150,000 + ($150,000 × 0.06 × 3/12) - = $150,000 + $2,250 - = 152,437.50 2.) A bank whose interest-sensitive assets total $350 million and its interest-sensitive liabilities amount to $175 million has: - An asset-sensitive gap of $175 million 3.) A bank plans on borrowing $150 million through an RP transaction collateralized by T- bills. It plans on borrowing the money for 5 days and the current RP rate is 5.25 percent. What is the bank’s total interest cost in dollars (hint: assumer 360 days in a year)? - =150,000,000*5.25%=7,875,000 - =7,875,000*5/360= 109,375 4.) The Third National Bank of Edmond reports a net interest margin of 5.83 percent. It has a total interest revenues of $275 million and total interest expenses of $210 million. This bank has earnings assets of $1,115 million. Suppose this bank’s interest revenues rise by 8 percent and its interest expenses and earnings assets rise by 10 percent next year, what is this bank’s new net interest margin? - Interest revenues = $275 million * 1.08 = $297 million - Interest expenses = $210 million * 1.10 = $231 million - Earning Assets = $1,115 million * 1.10 = $1,226.5 million

- New net interest margin = (Interest revenues - Interest expenses) / Earning Assets - New net interest margin = ($297 million - $231 million) / $1,226.5 million - New net interest margin = 0.0538 or 5.38% 5.) First National Bank has new loan requests of $225 million, needs to purchase $100 million in U.S Treasury securities to meet pledging requirements, and anticipates draws against credit lines of $135 million. Deposits received today total $215 million and the bank expects to bring in an additional $100 million next week. What is First National’s estimated funds gap for the coming week? - Funds need=225,000,000+100,000,000+135,000,000=460 million - Available= 215,000,000+100,000,000=315 million - =460,000,000-315,000,000= 145 million 6.) First National Bank has new loan requests of $175 million, needs to purchase $50 million in U.S Treasury securities to meet pledging requirements, and anticipates draws against credit lines of $45 million. Deposits received today total $140 million and the bank expects to bring in an additional $230 million next week. What is First National’s estimated funds gap for the coming week? - Funds need= 175,000,000+50,000,000+45,000,000=270 million - Available= 140,000,000+230,000,000=370 million - =270,000,000-370,000,000= -100 million

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7.) In the week about to begin, a bank expects $30 million in incoming deposits, $20 million in deposit withdrawals, $15 million in revenues from the sale of nondeposit services, $25 million in customer loan repayments, $5 million in sale of bank assets, $45 million in money market borrowings, $60 million in acceptable loan requests, $10 million in repayments of bank borrowings, $5 million in cash outflows to cover other operating expenses, and $10 million in dividend payments to its stockholders. The bank’s net liquidity position for the week is expected to be: - Total Cash Outflows = Deposit Withdrawals + Repayments of Bank Borrowings + Other Operating Expenses + Dividend To stockholders + Acceptable Loan Requests = $20M + $10M + $5M + $10M + $60M = $105 million - Total Cash Inflows = Incoming Deposits + revenues from the sale of non- deposit services + customer loan repayments + sale of bank assets + money market borrowings = $30M + $15M + $25M + $5M + $45M = $120 million - Net Liquidity Position Projected for the coming week = Total Cash Inflows - Total Cash Outflows = $120 million - $105 million = $15 million surplus 8.) First National Bank is planning to raise $30 million through an offering of negotiable CDs. The current rate for similar CDs is 5.5 percent. Noninterest cost rate for CDs is 0.25 percent. First National pays a deposit insurance premium of 0.0023 per dollar of insured deposits. Due to other immediate cash needs, only $25 million will be fully invested. What is the effective cost rate of borrowing in the CD market for the bank?

- 7.2 %