Consider the following situation in the Canadian banking system: • The Bank of Canada purchases $5 million worth of government securities   from an investment dealer with a cheque drawn on the Bank of Canada. • The dealer deposits this cheque at Bank XYZ, a commercial bank. • The target reserve ratio for all commercial banks is 20%. • All commercial banks operate with no excess reserves. • There is no cash drain. Bank XYZ is immediately in a position to expand its loans by     $1 million.     $5 million.     $25 million.     $4 million.     $3.75 million.

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Q: Part d

A:

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Required Reserve and Excess Reserve Analysis

A required reserve is an amount of cash that banks must keep with themselves, which is certain percentage of the deposits made by their customers. Required reserve is a percentage of the bank's deposits that the respective bank must have on each overnight. The percentage rate is set and determined by the nation’s central bank. It is important to have such funds accumulated to meet its uncertain obligations, sudden liabilities and withdrawals. Required reserve is also known as reserve ratio. Reserve ratio is an important tool to control the money supply.