Finance Commercial Bank Management 6

FIN 4324 Assignment 6

Name:

1. Suppose that Florida Bank has recently granted a loan of $2 million to Oyster Farms at

LIBOR plus 0.5 percent for six months. In return for granting Oyster Farms an interest-

rate cap of 6.5 percent on its loan, this bank has received from this customer a floor rate on

the loan of 5 percent. Suppose that, as the loan is about to start, LIBOR declines to 4.25

percent and remains there for the duration of the loan. How much (in dollars) will Oyster

Farms have to pay in total interest on this six-month loan with floor and without floor?

How much in interest rebates will Oyster Farms have to pay due to the fall in LIBOR?

2. What does securitization of assets mean?

3. What kinds of assets are most amenable to the securitization process?

4. What advantages does securitization offer to the lending institutions?

5. What was the motivation for creating collateralized mortgage obligations (CMOs) and

why is the creation of CMOs important for the market and/or investors?

6. What is a credit swap? For what kinds of situations was it developed?

7. Why is a credit default swap (CDS) useful?

8. What are the differences between a CDS contract and a conventional insurance contract?

9. Commercial banks have a unique ability to hedge against systematic liquidity shocks.

Discuss banks’ advantage in hedging liquidity risk relative to other financial institutions.

[Hint: The key point would be “natural hedge against liquidity risk”, so try to explain

this.]

[10-12] Assess the following bank’s liquidity situation:

10. Does this bank have any core deposits? If so, how much?

11. What is this bank’s financing gap? Briefly interpret this number.

12. Does this bank have any purchased liquidity? If so, how much?

13. BASEL III has proposed two new liquidity measures. What are they? Explain both of

them briefly in plain English.

14. BASEL I introduced risk-based capital ratios. What were the major problems with those

ratios? As U.S. Congress was not satisfied with the capital standards proposed by BASEL

I, the U.S. bank regulators included another capital measure. What was it?

Reserves at Fed $2,800 Fed funds purchased $3,500

Other cash $0 Demand deposits $15,000

U.S. Treasury securities $1,800 CDs less than $250,000 $5,000

Loans $27,000 Large CDs $3,000

Other assets $400 Equity $5,500

$32,000 $32,000