MGT411 Money & Banking Assignment 2 Solution Fall 2012

Question No. 1:
a) You are a bank manager and given the responsibility to manage the liquidity risk being faced by the bank. The Balance Sheet of the bank is given below:
Table: Balance sheet of a bank holding no excess reserves
Assets (in Million)
Liabilities (in Million)
Reserves Rs.15 million
Deposits Rs.90 million Rs.100million
Loans Rs.95 million
Borrowed funds Rs.35 million
Securities Rs.35 million
Bank capital Rs.20 million
A customer demands Rs.5 million cash withdrawals from the bank; what changes in the above Balance Sheet will occur if you decide to manage the liquidity risk through:
1. Adjusting assets by:
a. Selling the securities
b. Reducing the loans
2. Adjusting liabilities by:
a. Borrowings
b. Attracting deposits
Note: You are required to prepare four different Balance Sheets for each of the above mentioned strategies. (10 marks)
b) Discuss why bankers prefer liability management over asset management in order to mitigate liquidity risk? (5 marks)
Question No. 2:

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a) You, as a bank manager, are managing the bank’s assets and liabilities in such a way that interest rate the bank has to pay on its liabilities is 4% while interest rate the bank charges on its various assets is 6%. Suppose 30% of the bank’s assets fall into the category of interest-sensitive while others are not sensitive to the changes in interest rate. Similarly, half of the bank’s liabilities are interest-sensitive while rests of the half are not. What will be the impact on the profitability of the bank if theinterest rate rises by 1% on all assets and liabilities of the bank? (10 marks)
b) What will be the impact of increase in interest rate on the profitability of the bank if the bank has more interest-sensitive liabilities than interest-sensitive assets? (5 marks)

For Question # 1 (a)
Less 5 Million securities on asset side and withdraw 5 million deposit
For Question # 1 (b)
Reduce the loan by 5 Million on asset side
For Question # 1 (a) (Liability Side)
Add borrowed Funds by 5 Million and withdraw 5 million depost
For Question # 1 (b) (Liability Side)
The same balance sheet which is given in question