Problem:
Please help to evaluate the The new client just deposited $300,000 in a corporate checking account. Idle money means missing out on profits, so we want to put the additional funds to good use as soon as possible. We've identified three potential options for using the additional funds—you should evaluate the profitability and risk implications of each of the options listed below.
• Purchase additional government bonds. The selected securities are expected to yield about 4 percent per year.
• Purchase long-term AAA corporate bonds. The selected securities are expected to yield 7 percent per year.
• A loan to a local businessman to expand his business. The loan would have an interest rate of 10 percent.
The bank's current balance sheet, prior to the $300,000 deposit is provided below. The current reserve requirement on checkable deposits is 10 percent.
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X Bank
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Assets
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Cash reserves
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$420,000
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Short-term securities
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$2,080,000
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Long-term securities
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$2,500,000
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Loans
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$1,500,000
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Misc. assets
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$1,500,000
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Liabilities + Net Worth
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Checkable deposits
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$4,200,000
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Borrowed funds
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$1,300,000
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Equity
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$2,500,000
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$8,000,000
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$8,000,000
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Please include enough information in the response so that I can fully answer the following questions:
I need to recommend a course of action for the bank to pursue with a large new deposit. It should include:
• Explain how the new deposit will affect the bank's balance sheet and reserve requirements
• Identify the maximum amount of the deposit that can be used to acquire new assets
• Briefly describe, for each potential use of the funds, how the transaction would affect the bank's balance sheet and discuss how each option would affect the various risks faced by the bank (e.g., leverage risk, credit risk, interest rate risk, trading risk, and liquidity risk)
• Describe the importance of asymmetric information in evaluating each of the options
• Recommend an option or combination of options that the bank should pursue with the new funds