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Note: Please complete this exam and submit the solutions as homework. Pleasekeep a copy for yourself.

Management of Depository Institutions 2 !"!#$# %ample &uestionsfor 'inal

%pring 2$. (he following are the total asset )(*+ and a,erage cost )*-+ data for three

'Is. *- is calculated as cost per dollar of asset:

(* *- (- *-)merged+

*lphaMortgagebank

!$$M 2$ /////

0eta

1ife Ins. co

$$M !$ /////

3ammaPension fund

$$M 2# /////

Merged 4ntity

3amma knows it can reduce its a,erage cost by taking o,er *lpha and 0eta andcutting costs but is unsure about the magnitude of the cost reduction.

a. -alculate the total cost )(-+ of each firm and the total cost of the mergedentity if no cost cutting occurs. 5ow would you 6udge if the merger 6ustified7Discuss.

b. If operating costs fall by 89$M after the merger what will be the a,eragecost of the combined firm7

c. ;hat can be the sources of the decline in costs in this merger7

2. * corporation is planning to issue 8 $M of $=day %01- for an up=front fee of 2$ basis points to back the commercial paper issue7)?ou can re,iew & < from chapter !. It is similar to this+.

b. ;hat are the net sa,ings to the corporation if a bank agrees to pro,ide a 2>$=day loan commitment to back the issue7 (he bank will charge $ basis points for

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an up=front fee and $ basis points for a back=end fee for any unused portion ofthe loan. (he fees are one time charges. *ssume the loan will not be needed.

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Multiple Choice Questions. @sing a modified discriminant function similar to *ltmanAs a bank

estimates the following scoring model for its portfolio of loans: B C. / .$$ percent what should be the debt toasset ratio of the firm in order for the bank to appro,e the loan7

a. $.$ percentb. 9.# percentc. # .# percentd. # .$ percente. 9#.$ percent

@se the following information for Huestions 2= . * 8 $$ million loan commitmenthas an up=front fee of $ basis points )0P+ and a back=end fee of !$ bp on theunused portion.

2. (he up=front fee isa. 8 #$ $$$b. 8 $$$ $$$c. 8 $$ $$$d. 8!2# $$$e. 822# $$$

!. If #$ percent of the commitment is taken down the back=end fee isa. 8 #$ $$$b. 8 $$$ $$$c. 8 $$ $$$d. 8!2# $$$e. 822# $$$

. If 2# percent of the commitment is taken down the total fees area. 8 #$ $$$b. 8 $$$ $$$c. 8 $$ $$$d. 8!2# $$$e. 822# $$$

@se the following information for Huestions #=>. * corporation is planning toissue 8 $M worth of a 9=month commercial paper. In order to reduce the interestrates by )per annum+ it plans to back this issue with a standby letter of credit)%01-+ or a loan commitment. (he standby letter of credit is a,ailable for 2$

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basis points to be paid up=front. (he loan commitment for 8 $M is a,ailable for an up=front fee of # basis points and a # basis points back=end fee )fees areassessed on the entire loan amount+.#. ;hat is the net sa,ing to the corporation if it obtains a standby letter of

credit to back its 8 $ million issue of commercial paper7

a. 8 2#$b. 82#$$c. 8! >#$d. 8# $$$e. 89 2#$

9. ;hat is the net sa,ing to the corporation if it obtains a loan commitment toback its 8 $ million issue of commercial paper7

a. 8 2#$b. 8#$ $$$

c. 8! >#$d. 8# $$$e. 89 2#$

>. ;hich method is preferable between the loan commitment and the%01-7

a. Neither method is preferable o,er the other.a. (he standby letter of credit is preferable because the sa,ings are

greater.b. (he loan commitment is preferable it has a lower risk of default.

c. (he %01- is preferable because it has a lower risk of default.e. (he loan commitment is preferable because the back=end fee ispayable at the end of the period.

@se the following information for Huestions G= $. -onsider the following two 'Is:-ompany * has 8 2# million in total assets and total costs eHual to 8#$ million.-ompany 0 has 8 # million in total assets and total costs eHual to 89 million.

G. ;hat are a,erage costs per dollar of assets for each 'I7

a. 8$. $ for * and 82.#$ for 0.b. 8$. $ for both * and 0.c. 82.#$ for both * and 0.d. 82.#$ for * and 8$. $ for 0.e. insufficient information.

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a. (here are economies of scale because * and 0 coexist.b. (here is a natural monopoly condition in the banking industryc. (here are no scale economies because unit costs are fixedd. (here are scale economies because unit costs decline as siJe

increases.

e. (here are no scale economies because the unit costs increase withsiJe.

$. *ssume there is a third 'I )company -+ in the same market along with thetwo 'Is with 82$$ million in assets and total costs of 8 $# million. ;hatcan you conclude about the cost structure of the 'Is in this market7a. (here are significant scale economies because companies * 0

and -coexist in the industry.

b. (here are no significant economies of scale because bothcompanies * and - are much larger than company 0.

c. (here are no economies of scale because the unit costs areconstant.d. (here are scale diseconomies beyond the 8 2# million asset siJe.e. (here are no scale diseconomies because unit costs decrease as

siJe increases.

. Daylight o,erdraft riska. is contributed to by the failure to price intra=day loans at market

rates.b. is monitored closely by international bank regulators.c. %hould be of no concern because it is insignificant and cannot be

a,oided.d. is largest on the weekends.e. results from time Jone differences around the world.

2. (echnology is most important in which of the following bank lines ofbusiness7

a. -orporate cash=management ser,icesb. Kesidential mortgage lendingc. Issuance of consumer certificates of depositd. -redit appro,al for small loanse. None of the abo,e

!. ;hich of the following is not a wholesale banking ser,ice7a. -ontrolled disbursement accounts.b. *ccount reconciliation.c. 4lectronic funds transfer d. 4lectronic initiation of letters of credite. *utomated teller machines

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@se the following balance sheet )'igures are in thousands+ to answer Huestions= >.

*ssets 1iabilities and 4Huity-ash 2 Demand Deposits ##$

%ecurities !9< 'ed 'unds 0orrowed #1oans $$ 4Huity G #9$ b. 89 $ $ c. 822 $$$ d. 8 9 $$$ e. 8 >9$

#. 5ow can the bank meet a net deposit drain of 7a. 1iHuidate all cash holdings.b. Keduce fed funds loans made.

c. @se all of the cash and liHuidate some securities holdings.d. 1iHuidate all cash and some fed funds holdings.

e. make additional loans and deposit the proceeds to the customersLaccounts.

9. If the bank decides to cut down on interest expenses by reducing itsdependence upon borrowed funds what policy must the bank follow7a. Manage liHuidity risk exclusi,ely through asset management.b. Manage liHuidity risk exclusi,ely through liability management.

c. Keduce the bankLs dependence upon demand deposits. d. Increase interest income by increasing lending. e. Increase interest income by increasing securities holdings.

> If the bank experiences a 8#$ $$$ sudden liHuidity drain what will be theimpact on the bankLs balance sheet7a. * reduction in cash of 82 $$$ and an increase in demand deposits of

82< $$$.b. * reduction in cash of 82 $$$ and an increase in securities holdings of

82< $$$.c. * reduction in cash of 82 $$$ and a decrease in securities holdings of

82< $$$.

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d. * decrease in eHuity of 8#$ $$$.

G. ;hen an 'I pre=commits to lending at a fixed rate the fixed rate nature of the commitment exposes the bank to:

a. credit risk.

b. interest rate risk.c. takedown risk.d. funding riske. exchange rate risk.

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b. 0y obtaining access to low cost sources of funds.c. 0y impro,ing ser,ice Huality of the 'I.d. 0y inno,ating new interest earning products and charging fees for

them.e. 0y charging more on loans.

2 .5ow can interest income be increased by impro,ed technologicalefficiency7a. 0y impro,ing the efficiency of management of information flows.b. 0y obtaining access to low cost sources of funds.c. 0y charging lower fees on loansd. 0y inno,ating new interest earning products.e. 0y complying with all go,ernment regulations.

2#.;hich of the following is not a source of operational risk7a. -apital assets

b. -ustomer relationshipsc. (echnologyd. 4mployeese. Positi,e duration gap

29. ;hich of the following best describes economies of scale7 a. ccur when the a,erage cost decreases as the le,el of outputincreases.

b. -ost effects due to managerial ability and other hard=to=Huantify

factors.c. ccur when cost sa,ings are realiJed from using many of the sameinputs to produce multiple products.

d. ccur when the a,erage cost increases as the le,el of outputincreases.

e. ccur when cost increases are realiJed from using many of thesame inputs to produce multiple products.

2>. ;hich of the following statements is false7a. (he 'ed operates the 'edwire while -5IP% is a pri,ate network.b. 'edwire is owned by @.%. commercial banks and -5IP% is owned

by the go,ernment.c. (he 'ed guarantees all payments on 'edwire while -5IP%

transfers are pro,isional until settlement.d. Daylight o,erdrafts are incurred on both 'edwire and -5IP%.e. 'edwire does not charge market interest rate for daylight

o,erdrafts.

2G. -5IP%

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a. stands for clearing house interbank payment system.b. manages settlement risk by screening participating banks.c. manages settlement risk by making transfers pro,isional until

settlement.d. is owned pri,ately.

e. *ll of the abo,e. 2

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b. 8!$$ $$$c. 82$$ $$$d. 82#$ $$$e. 8 #$ $$$

!!.* disad,antage of using liability management to manage a 'ILs liHuidityrisk isa. the resulting shrinkage of the 'ILs balance sheet.b. the high cost of purchased liabilities.c. the accessibility of international money markets.d. increased profitability

e. the increased flexibility of using purchased funds.

! . * disad,antage of using asset management to manage a 'ILs liHuidity riskisa. the resulting shrinkage of the 'ILs balance sheet.

b. the high cost of purchased liabilities.c. the accessibility of international money markets.d. increased profitabilitye. increased dependence upon purchased liabilities.

!#. *n 'I has 8# million in cash reser,es with the 'ed in excess of its reser,ereHuirements 8# million in (=0ills and a credit line of 8 $ million to borrow in therepo market. It currently has lent 82 million in the 'ed 'unds market andborrowed 8 million from the 'ederal discount window to meet its seasonalneeds.

;hich of the following is 'alse7

a. the bankAs sources of liHuidity add up to 822 millionb. the bankAs current uses of liHuidity add up to 8 millionc. the net liHuidity of the bank is 82 milliond. a and b and c are correct.e. the net liHuidity of the bank is 822 million

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'ormulae

Duration: D C ntC -tO t") r+t " ntC -t") r+t

D C Q PRO PR2O 2 SS. PR n O n " PT

Interest rate sensiti,ity of bond prices:

) P"P+") K"K+ C =D K") K+

dP"P C =D dK") K+

*"* C =D * K") K+

1 C =D1 x 1 x ) K") K++

U U V D * = D1k *) K") K++

Modified duration: MD C D") K+.

D4*K C dollar ,alue of position W )=MD+ W ad,erse mo,e in daily yield

D4*K )'/+ C dollar ,alue of position W price ,olatility

D4*K )portfolio+ C D4*Ka2 D4*Kb2 D4*Kc2 2 ab W D4*Ka WD4*Kb 2 ac W D4*Ka WD4*Kc 2 bc W D4*Kb WD4*Kc "2

-ontractually promised gross return )k+ per dollar )when compensatingbalances are reHuired and reser,e reHuirements are in effect+ :

k C )of )0K m ++") =b) =RR + +

*ltmanAs model: BC .2/ . /2 !.!/ ! $.9/ .$/ #

4xpected loan payoff under credit risk C p) k+ ) =p+ ) k+ C i

Marginal mortality rate )default+: MMK C X U U U U U U UYZ U

X U U U U U [YZ

U U U U U U U U \ U U U X 1+

1 C =D1 x 1 x ) K") K++

1iHuidity index :I = w i (P i /P i *)

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