Answer Guide

BFW3651 TREASURY MANAGEMENT

Tutorial 3 Guided Answers

Semester 1, 2016

1. Indicate how a bank’s core deposits differ from its “hot money” or volatile liabilities in terms of interest elasticity. What factors are relatively more important for attracting and retaining core deposits as compared with purchased funds?

Core deposits represent relatively stable sources of funds. When rates change, few deposits will leave the bank in search of higher yields relative to volatile liabilities. Thus, the interest elasticity of core deposits is much lower than that for volatile liabilities. The key factor in attracting and retaining core deposits is the quality of service provided the customer. Individuals often choose their bank based on geographic location. Is the bank, a branch, or ATM near home or place of work? If so, a bank that offers competitive services and rates will retain the deposits as long as the bank meets the customer’s service quality standards. Commercial customers are also interested in convenience but tend to place a greater premium on the range of services offered and the personal attention provided by bank managers.

Research findings have shown that banks which relied on retail customer deposits were more resilient than banks that depended on wholesale funds purchased from the market. During the subprime and the eurozone sovereign debt crisis, financial markets became insular and stop funding the much liquidity needed by the troubled banks.

2. The Scenic national Bank gets its funds from Demand Deposits, Time Deposits, CDs, Subordinated Capital Notes and Common Stock. Scenic National Bank’s balance sheet is presented below with the costs of each source of funds (interest, acquisition and servicing costs) in parentheses. Scenic National Bank’s tax rate is 50%.

Scenic National Bank’s Balance Sheet (‘000)

Cash and due $100 | Demand deposits (0.04) $ 300 |

Investments 300 | Time...