Bora

1. Executive Summary (10%)

2. .Liquidity requirements of the banks(15%)

 The amount of cash that a bank holds is influenced by the bank’s liquidity requirements

 The size and volatility of cash requirements affect the liquidity position of the bank

Deposits, withdrawals, loan disbursements, and loan payments affect the bank’s cash balance and liquidity position

 Bank customers have become more rate conscious

 Many customers have demonstrated a a strong preference for shorter-term deposits

 Core deposits are viewed as increasingly valuable

 Bank often issue hybrid CDs to appeal to rate sensitive depositors

Funding sources of Banks

 Federal Funds Purchased

The term Fed Funds is often used to refer to excess reserve balances traded between banks

This is grossly inaccurate, given reserves averaging as a method of computing reserves, different non-bank players in the market, and the motivation behind many trades

Most transactions are overnight loans, although maturities are negotiated and can extend up to several weeks

Interest rates are negotiated between trading partners and are quoted on a 360-day basis

3. Average Historical Cost of Funds (20%)

Many banks incorrectly use the average historical costs in their pricing decisions

The primary problem with historical costs is that they provide no information as to whether future interest costs will rise or fall.

Pricing decisions should be based on marginal costs compared with marginal revenues

Av. Cost of Bank Liability =

Assuming, 5% float and 10% reserve requirements:

Average net cost of bank

= 2.38%

(Calculation adopted the example based on medium balance page 263 of text)

Usefulness

1. The primary problem with historical cost is that they provide no information as to whether future interest costs will rise or fall.

2. When interest rates rise, average historical costs understate the actual cost of issuing new debt.

3. When...