SOLUTION QUIZ 4
The following information is for questions 67-70. An FI has $5 million in cash reserves with the Fed in excess of its reserve requirements, $5 million in T-Bills, and a credit line of $10 million to borrow in the repo market. It currently has lent $2 million in the Fed Funds market and borrowed $1 million from the Federal discount window to meet its seasonal needs.
17-67What are the bank’s total available sources of liquidity?
a.$17 million
b.$18 million
c.$20 million
d.$21 million
e.$22 million
17-68What are the bank’s current total uses of liquidity?
a.$1 million
b.$3 million
c.$8 million
d.$10 million
e.$15 million
17-69What is the net liquidity of the bank?
a.$7 million
b.$12 million
c.$17 million
d.$21 million
e.$22 million
17-70Assume that the T-Bills can only be sold at a 10 percent discount, what is the net liquidity
of the bank given this information?
a.$6.5 million
b.$11.5 million
c.$16.5 million
d.$20.5 million
e.$21.5 million
17-71When comparing banks and mutual funds,
a.mutual funds have more liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
b.mutual funds have less liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
c.mutual funds have more liquidity risk than banks because all shareholders have the ability to withdraw their money on a first-come first basis.
d.mutual funds have less liquidity risk than banks because all shareholders have the ability to withdraw their money on a first-come first basis.
Q.2 DI has two assets: 50 percent in one-month Treasury bills and 50 percent in real estate Cloans. If the DI must liquidate its T-bills today, it receives $98 per $100 of face value; if it can wait to liquidate them on maturity (in one month’s time), it will receive $100 per $100 of face value. If the DI has to liquidate its real estate loans today, it receives $90 per $100 of face value liquidation at the end of one month will produce $92 per $100 of face value. The one-month liquidity index value for this DI’s asset portfolio is:
a..973
b..940
c..979
d.1.06
e.1.10
Q.3 Use the following information for questions 90-92. A corporation is planning to issue $10 million worth of 180-day commercial paper. In order to reduce the interest rates by 25 basis points (per annum), it plans to back this issue with a standby letter of credit or a loan commitment. The standby letter of credit is available for 20 basis points to be paid up-front. The loan commitment for $10 million is available for an up-front fee of 15 basis points and a 5 basis points back-end fee.
13-90What are the savings to the corporation if it obtains a standby letter of credit to back its
$10 million issue of commercial paper?
a.$1,250
b.$2,500
c.$3,750
d.$5,000
e.$6,250
13-91What are the savings to the corporation if it obtains a loan commitment to back its $10
million issue of commercial paper?
a.$1,250
b.$2,500
c.$3,750
d.$5,000
e.$6,250
Q.4 How does one distinguish between an off-balance-sheet asset and an off-balance-sheet liability?
Off-balance-sheet activities or items are contingent claim contracts. An item is classified as an off-balance-sheet asset when the occurrence of the contingent event results in the creation of an on-balance-sheet asset. An example is a loan commitment. If the borrower decides to exercise the right to draw down on the loan, the FI will incur a new asset on its portfolio. Similarly, an item is an off-balance-sheet liability when the contingent event creates an on-balance-sheet liability. An example is a standby letter of credit (LC). In the event that the original payer of the LC defaults, then the FI is liable to pay the amount to the payee, incurring a liability on the right-hand side of its balance sheet.
Q.5 What are the characteristics of a loan commitment that an FI may make to a customer? In what manner and to whom is the commitment an option? What are the various possible pieces of the option premium? When does the option or commitment become an on-balance-sheet item for the FI and the borrower?
A loan commitment is an agreement to lend a fixed maximum amount of money to a firm within some given amount of time. The interest rate or rate spread normally is determined at the time of the agreement, as is the length of time that the commitment is open. Because the firm usually triggers the timing of the draw, which may be any portion of the total commitment, the commitment is an option to the borrower. If the loan is not needed, the option or draw will not be exercised. The premium for the commitment may include a fee of some percent times the total commitment and a fee of some percent times the amount of the unused commitment. Of course the borrower must pay interest while any portion of the commitment is in use. The option becomes an on-balance-sheet item for both parties at the point in time that a draw occurs.
Q.6 How do standby letters of credit differ from commercial letters of credit? With what other types of FI products do SLCs compete? What types of FIs can issue SLCs?
Standby letters of credit usually are written for contingency situations that are less predictable and that have more severe consequences than the LCs written for standard commercial trade relationships. Often SLCs are used as performance guarantees for projects over extended periods of time, or they are used in the issuance of financial securities such as municipal bonds or commercial paper. Banks and property-casualty insurance companies are the primary issuers of SLCs.