Point/Counter – Point Should Banks Engage in Other Financial Services Besides Banking? Point: No, Banks should focus on what they do best. Counter – Point: yes, Banks should increase their value by engaging in other services. They can appeal to customers who want to have all their financial services provided by one financial institution. Who is correct? Use the internet to learn more about this issue. Offer your own opinion on this issue. Answer: Many Banks have expanded their services by acquiring other types of financial institutions that can provide the services.
However, they sometimes pay too much for the institutions that can offer these services. In general, offering additional services can be beneficial if the bank does not incur excessive costs from offering these services. Questions and Answer season 1. Bank Balance Sheet. Create a balance sheet for a typical bank, showing its main liabilities (sources of funds) and assets (uses of funds). ANSWER: Liabilities 1. Transaction deposits 2. Savings deposits 3. Time deposits 4. Money market deposit accounts 5. Federal funds purchased 6. Repurchase agreements 7. Eurodollar borrowings Assets 1. Cash 2. Loans 3.
Investment securities 4. Federal funds sold 5. Repurchase agreements 6. Eurodollar loans 7. Fixed assets 2. Bank Sources of Funds. What are four major sources of funds for banks? What alternatives does a bank have if it needs temporary funds? What is the most common reason that banks issue bonds? ANSWER: 1. Transaction deposits 2. Savings deposits 3. Time deposits 4. Money market deposit accounts Sources of temporary funds include: 1. Federal funds market 2. Discount window 3. Repos 4. Eurodollar borrowings Banks may issue bonds to purchase fixed assets. 3. Compare and contrast the retail CD and the negotiable CD.
ANSWER: Retail CDs and negotiable CDs (NCDs) both specify a minimum deposit, a stated maturity, and a stated interest rate. Yet, NCDs differ from retail CDs because their minimum investment is much higher. In addition, they can be sold in a secondary market, whereas there is no secondary market for retail CDs. 9. Bullet Loan. Explain the advantage of a bullet loan. ANSWER: A bullet loan represents a loan whose principal is paid off in one lump sum. That is, a bullet loan specifies a balloon payment at a future point in time. This type of loan is useful for a borrower will have limited funds in the near future. 0. Bank Use of Funds. Why do banks invest in securities, even though loans typically generate a higher return? How does a bank decide the appropriate percentage of funds that should be allocated to each type of asset? Explain. ANSWER: Securities provide a bank with liquidity, because they can often be sold easily in the secondary market. In addition, many securities purchased by banks have low risk. Therefore, the securities can be used to minimize liquidity risk and default risk. The optimal allocation of funds is dependent on a bank’s degree of risk aversion and anticipated economic conditions.
There is no formula to determine the optimal allocation. Banks must weigh the higher potential return from some uses of funds against the lower return and lower risk of other uses of funds. 11. Bank Capital. Explain the dilemma faced by banks when determining the optimal amount of capital to hold. A bank’s capital is less than 10 percent of its assets. How do you think this percentage would compare to that of manufacturing corporations? How would you explain this difference? ANSWER: Banks may prefer a low level of capital because they can possibly achieve a higher return to shareholder (higher earnings per share).
However, regulators enforce minimum capital requirements so that a bank’s capital is sufficient to absorb operating losses that could occur. Banks are more highly leveraged (less capital and more liabilities) than manufacturing companies because their future cash inflows are much more predictable. They can handle the future payments due to liabilities, because they know the future level of cash inflows. Interpreting Financial News Interpret the following statements made by Wall Street analysts and portfolio managers. a. “Lower interest rates may reduce the size of banks. ”
Lower interest rates are beneficial because they can increase the spread between the interests banks earn on their assets versus the interest they pay on their liabilities. However, when interest rates are very low, many households may withdraw bank deposits and invest their money in stock mutual funds or in other investments to earn a higher return. Bank assets could be reduced as a result of the withdrawals. b. “Banks are no longer as limited when competing with other financial institutions for funds targeted for the stock market. ” A bank’s traditional services do not include investing funds for individuals in the stock market.
However, banks are now commonly affiliated with brokerage firms or mutual funds and can offer services through them that serve individuals that invest in stocks. c. “If the demand for loans rises substantially, interest rates will adjust to ensure that commercial banks can accommodate the demand. ” If loan demand rises, interest rates on deposits and loans will increase. Thus, the high deposit rate will attract more funds, while the high loan rate will discourage some potential borrowers from obtaining loans. The interest rate adjusts to the point at which the supply of deposits is adequate to accommodate loan demand.