Chapter 12, Problem 6E

To determine

(a)

To prepare:

The balance sheet for the bank.

Answer to Problem 6E

Balance sheet for the First Bank is as represented below:-

Assets	Amount ($)	Liabilities	Amount($)
Cash	$\$200,000$	Deposits	$\$1,000,000$
Loan	$\$800,000$
Total	$\$1,000,000$	Total	$\$1,000,000$

Explanation of Solution

Given Information:

Cash reserves are of $\$200,000$, loans are of $\$800,000$ and deposits are of $\$1,000,000$.

An asset includes cash and loan.Summing up the given values:

$\begin{array}{c}\text{Assets}=\text{Cash}+\text{Loan}\\ =\$2,00,000+\$8,00,000\\ =\$1,000,000\end{array}$

Also, liabilities for bank includes deposits as they are assets of depositor owned by banks which is $\$1,000,000.$

Therefore, the balance sheet would be presented as

Assets	Amount($)	Liabilities	Amount($)
Cash	$200,000$	Deposits	$1,000,000$
Loan	$800,000$
Total	$1,000,000$	Total	$1,000,000$

Here, the total amount of assets is equal to total amount of liabilities.

Economics Concept Introduction

Balance sheet:

It is a financial record of the company that consists of information about their assets and liabilities. The balance sheet represents that the total liabilities matches the total assets.

Assets of the bank would consists of cash, interest-earning loans, where as liabilities will include debts that needs to be paid by the bank.

To determine

(b)

To compute:

The largest loan a bank can make if the bank maintains a reserve requirement of $15$ percent.

Answer to Problem 6E

The largest amount of loan that can be made by the bank after maintaining reserve of $15$

Percent is $\$333,334$.

Explanation of Solution

Given Information:

Cash reserves are of $200,000, loans are of $800,000, and deposits are of $1,000,000.

Reserve requirement is of $15$ percent

Calculate the excess reserve:-

  $\begin{array}{c}\text{ER}=\text{Cash}\text{Reserve}-\text{Required}\text{Reserve}\\ =\text{\$2,00,000}-\$150,000\\ =\$50,000\end{array}$

Now, the maximum money supply that can be expanded:

$\frac{1}{0.15}\times 50,000=\$333,334$

Working Note:

To calculate reserve ratio of $15$ percent,

  $\begin{array}{c}RR=r\times D\\ =0.15\times \$1,000,000\\ =\$150,000\end{array}$

Economics Concept Introduction

Required reserve:

It refers to a certain amount of cash from the deposit that bank needs to keep according to the guidelines of central bank.

Required reserve ratio is calculated by

$RR=r\times D$

Here, RR is required reserve, r is percentage of required reserve and D is the total amount in deposits.

Excess reserve:

It refers to the amount left after separating the required reserve ratio of the financial institution.

$\text{ER}=\text{Cash}\text{Reserve}-\text{Required}\text{Reserve}$

To determine

(c)

To compute:

The maximum amount by which the money supply can be increased as result of First Bank's new loan.

Answer to Problem 6E

The maximum amount by which the money supply can be increased as result of F Bank's new loan is $\$1,000,000.$

Explanation of Solution

Given Information:

Cash reserves are of $200,000, loans are of $800,000, and deposits are of $1,000,000.

Calculate the excess reserve:-

  $\begin{array}{c}\text{ER}=\text{Cash}\text{Reserve}-\text{Required}\text{Reserve}\\ =\text{\$2,00,000}-\$50,000\\ =\$150,000\end{array}$

Therefore, the money supply that can be expanded is

$\frac{1}{0.15}\times 150,000=\$1,000,000$

Working Note:

According to the given information, new reserve ratio would be

  $\begin{array}{c}RR=r\times D\\ =0.15\times \$333,334\\ =\$50,000\end{array}$

Economics Concept Introduction

Required reserve:

It refers to a certain amount of cash from the deposit that bank needs to keep according to the guideline of the central bank.

Required reserve ratio is calculated by

$RR=r\times D$

Here, RR is required reserve, r is percentage of required reserve and D is the total amount in deposits.

Excess reserve:

It refers to the amount left after separating the required reserve ratio of the financial institution.

$\text{ER}=\text{Cash}\text{Reserve}-\text{Required}\text{Reserve}$

To determine

(d)

To compute:

The largest loan and increase in money supply by the bank, If the reserve requirement is reduced to 12 percent.

Answer to Problem 6E

The money supply that can be expanded is equal to $\$666,666$.

Explanation of Solution

Given Information:

Cash reserves are of $200,000, loans are of $800,000, and deposits are of $1,000,000.

Calculate the excess reserve:-

  $\begin{array}{c}\text{ER}=\text{Cash}\text{Reserve}-\text{Required}\text{Reserve}\\ =\text{\$2,00,000}-\$120,000\\ =\$80,000\end{array}$

Therefore, the increase in amount of the money supply is

$\frac{1}{0.12}\times 80,000=\$666,666$

Working Note:

According to the given information,new reserve ratio would be

  $\begin{array}{c}RR=r\times D\\ =0.12\times \$1,000,000\\ =\$120,000\end{array}$

Economics Concept Introduction

Introduction:

Required reserve:

It refers to a certain amount of cash from the deposit that bank need to keep according to the guideline of central bank.

Required reserve ratio is calculated by

$RR=r\times D$

Here, RR is reserve ratio, r is percentage of required reserve and D is the total amount in deposits.

Excess reserve:

It refers to the amount left after separating the required reserve ratio of the financial institution.

$\text{ER}=\text{Cash}\text{Reserve}-\text{Required}\text{Reserve}$