Economics 411 - Money and Banking Spring 2024
Homework 2
Due April 23, 2024
1 Short-answer Questions
1. [Q.2 Ch.9] Suppose Melvin’s Bank starts with the balance sheet in Table 9.4A (given below). Then the bank sells $10 of loans for $10 of cash.
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Table 9.4 Liquidity Risk at Melvin’s Bank
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(A) Initial Balance Sheet
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(B) Balance Sheet After $50 Withdrawal
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Assets
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Liabilities and Net Worth
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Assets
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Liabilities and Net Worth
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Reserves 10
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Checking Deposits 50
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Reserves 0
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Checking Deposits 50
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Securities 30
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Non-transaction Deposits 50
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Securities 0
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Non-transaction Deposits 0
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Loans 80
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Net Worth 20
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Loans 60
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Net Worth 10
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TOTAL 120
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TOTAL 120
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TOTAL 60
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TOTAL 60
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(a) What is the immediate effect of the balance sheet?
(b) After the loan sale, what additional transactions is the bank likely to make? What will the balance sheet look like after these transactions?
2. [Q.6 Ch.10] Suppose Melvin’s Bank can make a bet on derivatives that has a 2/3 probability of earning $20 and 1/3 probability of losing $40.
(a) Assume Melvin has $20 in capital. What are the possible costs and benefits of the bet for Melvin and the deposit insurance fund? Is Melvin likely to make the bet?
(b) How are the answers in part (a) different if Melvin’s Bank has $50 in capital? What if it has $0 in capital?
(c) In light of these examples, discuss the benefits of (i) capital requirements, (ii) bank supervision, and (iii) quick closure of insolvent banks.