Chapter 12 Flashcards
(21 cards)
What type of intermediaries will we focus on?
Banks (depository institutions)
What is a balance sheet what is the formula for the balance sheet?
A balance sheet is a list of assets and liabilities
Formula:
Total Assets = Liabilities + Capita
What would a bank’s liabilities and assets be?
- Liabilities are the bank’s sources of funds
– Note: (Bank) capital = equity of the bank - Assets are the bank’s investments or uses of funds
Slides 6-7 Assets and liabilities of banks
What is vault cash?
Settlement balances (deposits at the Bank of Canada)
plus currency physically held by banks (called vault
cash)
Slides 9-12 basic transactions of a bank
What are the four general principles of bank management?
- Liability Management (involves the acquisition of funds at low cost)
- Liquidity Management (involves making sure that the bank
has enough ready cash to pay depositors when there are deposit outflows) - Capital Adequacy Management (involves determining the amount of capital the bank should maintain and then acquiring the needed capital)
- Asset Management (involves risk minimization by acquiring assets that have a low rate of default and by diversifying asset holdings)
– Managing credit risk
– Managing interest-rate risk
What is a money center bank?
large banks (called money center banks) began to explore ways to manage their liabilities
What are the ways a bank can deal with a shortfall in reserves?
- Borrowing from other banks or corporations
- Sell some securities
- Borrow from the Bank of Canada
- Call-in loans (most costly and antagonizes customers or forces them to sell to other banks at large discounts)
What are the three asset management goals for banks? And what are the four ways to accomplish this?
To maximize profits, banks must seek the highest
possible returns on loans and securities, reduce risk,
and have adequate liquidity.
Four basic ways to accomplish these goals
1. Find low-risk borrowers that pay high interest rates
2. Purchase securities with high returns and low risk
3. Diversifying their asset holdings
4. Manage liquidity to meet deposit outflow
What are three reasons banks have to make decisions about the amount of capital they need to hold?
- Bank capital helps prevent bank failure
- The amount of capital affects return for the
owners (equity holders) of the bank - A minimum amount of bank capital (bank capital
requirements) is required by regulatory authorities
such as OSFI)
What is the leverage formula?
Leverage (= EM ) = Assets/(Assets – Liabilities)
and is a measure of how much debt an investor assumes in making an investment.
Slide 25 leverage cycles
What is the formula for ROA and ROE?
Return on Assets: net profit after taxes per dollar of assets
ROA = net profit after taxes / assets
Return on Equity: net profit after taxes per dollar of equity capital
ROE = net profit after taxes / equity capital
What is the formula for the equity multiplier and how can it help calculate ROE?
Equity Multiplier: the amount of assets per dollar of
EM = Equity capital / Assets
ROE = ROA x EM
Slide 28 Capital adequacy management: Safety
Briefly explain interest rate risk.
- If a financial institution has more interest rate
sensitive liabilities than interest rate sensitive
assets, a rise in interest rates will reduce income - If a financial institution has more interest rate
sensitive assets than interest rate-sensitive
liabilities, a rise in interest rates will raise income
What is GAP and what does it calculate?
The GAP is the difference between interest rate sensitive assets and interest rate sensitive liabilities
GAP = rate-sensitive assets – rate-sensitive liabilities
GAP = RSA – RSL
How can we calculate the change in income using GAP?
A change in the interest rate (Δi) will change bank income depending on the GAP, as follows:
ΔIncome = GAP x Δi
What is duration analysis?
Duration Analysis examines the sensitivity of the
market value of the financial institution’s net worth
(NW) to changes in interest rates
*Slide 39-41 Duration formula
