CHAPTER 11

Week 7 Class Exercises

1. Ocean View State Bank estimates that over the next 24 hours the following cash inflows
and outflows will occur (all figures in millions of dollars):

Deposit withdrawals $100 Sales of bank assets $ 40

Deposit inflows 95 Stockholder dividend payments 150
Revenues from sale of nondeposit
Scheduled loan repayments 90 services 95
Acceptable loan requests 60 Repayments of bank borrowings 60
Borrowings from the money
market 80 Operating expenses 50

What is this bank’s projected net liquidity position in the next 24 hours? From what sources can
the bank cover its liquidity needs?

Deposit withdrawals $100 −

Deposit inflows $95 +
Scheduled loan repayments $90 +
Acceptable loan requests $60 −
Borrowings from the money market $80 +
Sales of bank assets $40 +
Stockholder dividend payments $150 −
Revenues from sale of nondeposit
services $95 +
Repayment of bank borrowings $60 −
Operating expenses $50 −

= [$95 + $90 + $80 + $40 + $95] − [$100 + $60 + $150 + $60 + $50]
= 400 − 420
= −$20 million.

Faced with an expected liquidity deficit, Ocean View State Bank could arrange to increase its
money market borrowings from other institutions or sell some of its assets or do some of both.

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2. Mountain Top Savings is projecting a net liquidity deficit of $10 million next week partially as
a result of expected quality loan demand of $32 million, necessary repayments of previous
borrowings of $15 million, planned stockholder dividend payments of $10 million, expected
deposit inflows of $26 million, revenues from nondeposit service sales of $18 million, scheduled
repayments of previously made customer loans of $23 million, asset sales of $10 million, other
operating expenses of $15 million, and money market borrowings of $15 million. How much
must Mountain Top’s expected deposit withdrawals be for the coming week?

Supply of Liquidity Flowing into the Mountain Top Savings

Expected deposit inflows $26
Revenues from nondeposit service sales 18
Scheduled repayments of previously made customer loans 23
Asset sales 10
Money market borrowings 15
Total Source of Liquidity

Demands on the Mountain Top Savings for Liquidity

Expected quality loan demand 32
Necessary repayments of previous borrowings 15
Other operating expenses 15
Stockholder dividend payments 10
Total Uses of Liquidity Excluding Deposit Withdrawals

Net liquidity deficit = Liquidity supplies − Liquidity demands − Deposit withdrawals

−$10 million = $92 million − $72 million − Deposit withdrawals
Deposit withdrawals = $30

Therefore, expected deposit withdrawals must equal $30 million for the next week.

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3. Suppose Abigail Savings Bank's liquidity manager estimates that the bank will
experience a $375 million liquidity deficit next month with a probability of 15 percent, a $200
million liquidity deficit with a probability of 35 percent, a $100 million liquidity surplus with a
probability of 35 percent, and a $250 million liquidity surplus bearing a probability of 15
percent. What is this savings bank’s expected liquidity requirement? What should management
do?

Liquidity Deficits or Associated

Surpluses Probabilities
-$375 million 15 percent
-$200 million 35 percent
+$100 million 35 percent
+$250 million 15 percent
100 percent

The bank's expected liquidity requirement is:

Expected Liquidity Requirement = 0.15 × (-$375 million) + 0.35 × (-$200 million) +
0.35× (+$100 million) + 0.15 × (+$250 million)
= -$56.25 million - $70 million + $35 million + $37.5 million
= -$53.75 million

Faced with an expected liquidity deficit the bank's liquidity manager must still begin preparing
for meeting the institution's cash needs through arranging for credit lines or deposits from other
banks and actual or potential deposit customers and strengthening the bank's liquid asset
position.

4. First Savings of Rainbow, Iowa, reported transaction deposits of $75 million (the daily
average for the latest two-week reserve computation period). Its nonpersonal time deposits over
the most recent reserve computation period averaged $37 million daily, while vault cash
averaged $5 million. Assuming that reserve requirements on transaction deposits are 3 percent
for deposits over $10.7 million and up to $58.8 million and 10 percent for all transaction deposits
over $58.8 million while time deposits carry a 3 percent required reserve, calculate this savings
institution’s required daily average reserve balance.

Daily required reserves at Fed

= [($58.8 − 10.7) × 0.03] + [($75 – $58.8) × 0.10] + [$37 × 0.03] − $5
= $1.443 + $1.62 + $1.11 − $5= $4.173 − $5.= − $0.827 million

5. Parvis Bank and Trust Co. has calculated its daily average deposits and vault cash
holdings for the most recent two-week computation period as follows:

Net transaction deposits = $ 90,000,000

Nonpersonal time deposits under
18 months to maturity = $169,000,000

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 Eurocurrency liabilities = $ 7,000,000
Daily average balance in vault cash = $ 2,000,000.

Suppose the reserve requirements posted by the Board of Governors of the Federal Reserve
System are as follows:

Net transaction accounts:

$10.7 to $58.8 million 3%
More than $58.8 million 10%
Nonpersonal time deposits:
Less than 18 months 3%
18 months or more 0%
Eurocurrency liabilities—all types 3%

What is this bank's daily average required level of legal reserves? How much must the bank hold
on a daily average basis with the Federal Reserve bank in its district?

[($58.8 million − 10.7 million) × 0.03] + [($90 million − $58.8 million) × 0.10] + [($169 million
+ $7 million) × 0.03]
= $1.443 million + $3.12 million + $5.28 million = $9.843 million
Daily average reserve holdings: $9.843 million − $2 million = $7.843 million

6. Why do financial firms face significant liquidity management problems?

Financial institutions are prone to liquidity management problems due to:

(1) A maturity mismatch situation in which most depository institutions hold an unusually high
proportion of liabilities subject to immediate payment, especially demand (checkable) deposits
and money market borrowings. Whereas, they use these funds to make long-term credit available
to their borrowing customers. The institution faces an imbalance between the maturity dates
attached to their assets and the maturity dates of their liabilities.

(2) The sensitivity of changes to their assets and liabilities values towards market interest-rate
movements. When interest rates rise, some customers will withdraw their funds in search of
higher returns elsewhere. Many loan customers may postpone new loan requests or speed up
their drawings on those credit lines that carry lower interest rates. Thus, changing market interest
rates affect both customer demand for deposits and customer demand for loans, each of which
has a potent impact on a depository institution’s liquidity position.

(3) Their central role in the payments process is that financial firms must give high priority to
meeting demands for liquidity. To fail in this area may severely damage public confidence in the
institution.

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