Homework Questions

1. Create a balance sheet for a typical bank, showing its main liabilities (sources of funds) and assets (uses of funds).

2. Describe the process of “borrowing at the Federal Reserve.” What rate is charged, and who sets it? Why do banks commonly borrow in the federal funds market rather than through the Federal Reserve?

3. 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?

4. What is accomplished when a bank integrates its liability management with its asset management?

5. What is the formula for the net interest margin? Explain why it is closely monitored by banks.

6. What are the two ways in which a bank should diversify its loans? Why? Is international diversification of loans a viable strategy for dealing with credit risk? Defend your answer.

7. Does the use of floating-rate loans eliminate interest rate risk? Explain.

8. How can gross interest income rise while the net interest margin remains somewhat stable for a particular bank?

9. If a bank shifts its loan policy to pursue more credit card loans, how will its net interest margin be affected?

10. What has been the trend in noninterest income in recent years? Explain.