商业银行管理 ROSE 7e 课后答案chapter_06

CHAPTER 4CREATING AND MANAGING SERVICE OUTLETS:NEW CHARTERS, BRANCHES, AND ELECTRONIC FACILITIESGoal of This Chapter: The purpose of this chapter is to learn how new banks are chartered by state and federal authorities in the United States, to determine what makes a good site for a new branch office, to recognize how the role of branch offices is changing, and to explore the advantages and disadvantages of automated banking facilities.Key Topics in This Chapter•Chartering New Financial Service Institutions•Performance of New Banks•Establishing Full Service Branches•In-Store Branching•Establishing Limited Service Facilities•ATMs and Telephone Centers•The Internet and Online BankingChapter OutlineI. IntroductionA. The Importance of Convenience and Timely Access to CustomersB. Service Options Available Today1. Chartering New (De Novo) Financial Institutions2. Establishing New Full-Service Branches3. Setting Up Limited-Service FacilitiesII.Chartering a New Bank or Other Financial Service InstitutionsIII.The Bank Chartering Process in the United StatesA. The Chartering Authorities in the U.S.B. Benefits of Applying for a National CharterC. Benefits of Applying for a State CharterIV. Questions Regulators Usually Ask the Organizers of a New BankV. Factors Weighing on the Decision to Seek a New Bank CharterA. External Factors1. Level of Economic Activity2. Growth of Local Economic Activity3. The Need for a New Bank4. Strength and Character of Local Competition in Supplying FinancialServicesB. Internal Factors1. Qualifications and Contacts of the Organizers2. Management Quality3. Pledging of Capital and Funds to Cover the Cost of Filing a CharterApplication and Getting UnderwayVI. Volume and Characteristics of New Bank ChartersA. Numbers of New ChartersB. Characteristics of New Charter MarketsVII. How Well Do New Banks PerformA. New Bank Financial PerformanceB. Pro-Competitive Effects on Service Offerings and Service PricingVIII. Establishing Full-Service Branch Offices: Choosing Locations and Designing New BranchesA. Advantages of Full-Service BranchesB. Trends in the Design of New BranchesC. Desirable Sites for New BranchesD. Expected Rate of ReturnE. Geographic DiversificationF. Branch RegulationG. The Changing Role of BranchesH. In-Store BranchingIX. Establishing and Monitoring Automated Limited-Service FacilitiesX. Point-of-Sale TerminalsXI. Automated Tellers (ATMs)A. History of ATMsB. ATM ServicesC. Fee Structures for ATM UsageD. Customer Service Limitations of ATMsE. Example of the ATM Capital-Budgeting DecisionXII. Home and Office Online BankingA. Telephone Banking and Call CentersB. Internet Banking1. Services Provided Through the Internet2. Challenges in Providing Internet Services3. The Net and Customer Privacy and SecurityXIII. Financial Service Facilities of the FutureXIV. Summary of the ChapterConcept Checks4-1. Why is the physical presence of a bank still important to many bank customers despite recent advances in long-distance communications technologyMany customers still prefer the personal attention and personal service that contact with bank employees provides. Moreover, for those services where problems can arise that require detailed information and explanation-for example, when a checking account is overdrawn and checks begin to bounce-the customer needs quick access and, often, the personal attention to his or her problem on the part of one or more employees.4-2. Why is the creation (chartering) of new banks closely regulated What about nonblank financial firmsThe creation of new banks is regulated to insure the safety and soundness of existing banks and to avoid excessive numbers of bank failures. The same arguments are usually made for non-bank financial firms. Financial-Service fi rms hold the public’s savings, are the heart of the payment system and create money. The failure of these firms could disrupt the economy and too many could mean in excessive growth in the money supply and inflation.4-3. What do you see as the principal benefits and costs of government regulation of the number of financial service charters issuedWhile control over the entry of new banks may reduce the number of failures, it also limits competition, so that the public may receive a smaller volume or lower quality of services at excessive prices.4-4. Who charters new banks in the United States New thrift institutionsNew banks are chartered by the banking commissions of the individual states or, at the federal level, by the Comptroller of the Currency. Thrift institutions are chartered by the states or at the federal level by the Office of Thrift Supervision.4-5. What key role does the FDIC play in the chartering processThe FDIC exercises some control over state bank charter activity as well as federal charters because most states insist that their new banks qualify for federal deposit insurance before they can open for business.4-6. What are the advantages of having a national bank charter A state bank charterThe benefits of a national charter are:a.)It brings prestige due to stricter regulations and may help attract more customersb.)In times of trouble the technical assistance given may be better ensuring a betterchance of long run survivalThe benefits of a state charter are:a.)It may be easier and less costly to get a state charterb.)The bank does not have to join the Federal Reserve and therefore avoids buying andholding low yield stock of the Federal Reservec.)Many states let a bank lend more to one borrowerd.)State chartered banks may be able to make types of loans that a nationally charteredbank cannot4-7. What kinds of information must the organizers of new national banks provide the Comptroller of the Currency in order to get a charter Why might this required information be importantThe Comptroller of the Currency asks for information on the number of competing banks and bank-like institutions in the service area of the proposed bank. More competitive market situations limit the profit potential and perhaps the growth potential of a new bank. Also requested is information about shopping centers, retail and wholesale business activity, recent population growth, traffic counts, and personal income levels - all viewed as indicators of potential demand for banking services in the service area of the proposed new bank. Applicants must also provide background information on the organizers and proposed management of a new bank so the Comptroller can decide if these people are qualified, law-abiding, and trustworthy to manage the public's funds as well as their own.4-8. Why do you think the organizers of a new financial firm are usually expected to put together and submit to the chartering authority a detailed business plan, including marketing, management, and financial componentsThis demonstrates to regulators that the organizers of the bank have the expertise, experience and skills necessary to be successful in managing the new bank. If the organizers of a bank do not know where they are going, they are unlikely to be successful. In addition, it demonstrates whether the organizers of the new bank have a realistic picture of the community they are planning on serving and whether the organizers have a realistic view of the profit potential in the new bank. 4-9. What are the key factors the organizers of a new financial firm should consider before deciding to seek a charterWhile a variety of factors are examined by different business people interested in establishing a new bank, most look at some or all of the following factors.1. External Factorsa. The level of local economic activity.b. Growth of local economic activity.c. The need for a new bank.d. The strength and character of local competition in supplying financialservices.2. Internal Factorsa. Qualifications and contacts of the new bank's organizers.b. Management quality.c. Pledging of capital and funds to cover the cost of filing a charter applicationand begin operations.4-10. Where are most new banks chartered in the United StatesNew charters tend to be concentrated in large urban areas where expected rates of return on the organizers investments are likely to be the highest. As the population increases relative to the number of financial firms, the number of new charters increases. The success of local banksalready in the area suggests that new financial firms would also be successful. Places where the concentration ratio for new banks has increased tend to have fewer new bank charters.4-11. How well do most new banks perform for the public and for their ownersMost new banks succeed, especially those whose organizers can bring in new deposits and loan accounts during the first year of the bank's operation. Most are profitable within two to three years of opening. There is some evidence that newly charted banks are financially ‘fragile’ and more prone to failure than existing banks. They appear to be more vulnerable to real estate crises than established banks. New banks tend to under perform their competitors until they have been around for a while and new banks are more closely supervised than established banks.4-12. Why is the establishment of new branch offices usually favored over the chartering of new financial firms as a vehicle for delivering financial servicesThe chartering of a new financing corporation is normally a lengthy and expensive process, requiring the completion of elaborate federal or state application forms, while the branch application process is normally far simpler and less costly. Moreover, with the increase in the number of failures in recent years regulatory-imposed capital requirements for new charters have increased substantially, while new branch offices usually carry significantly lower capital requirements. Moreover, branch offices themselves are often much less elaborate and costly to build and maintain than are the headquarters' facility of a new institution where some duplicate facilities can be eliminated (for example, checking processing, credit analysis, and records departments).4-13. What factors are often considered in evaluating possible sites for new branch offices Bankers first need to decide the goals and objectives of a new facility. Often this means assessing whether the proposed new branch is aimed at selling one or more particular services, such as deposits or loans, and also deciding how closely correlated cash flows and returns from the new branch office may be with cash flows and returns from the other facilities operated by the bank. If returns or cash flows through the proposed new institution are negatively correlated or display low positive correlation with the institution's other facilities, they may be able to lower the variance of its returns or cash flows by proceeding to establish the new office.Other considerations revolve around the economic strength of the proposed branch officesite-whether there is adequate traffic volume, large numbers of stores and shops, older or younger age populations who often require slightly different menus of services, recent area population growth, density and income, the occupational and residential makeup of the proposed new branch area, a large enough population to generate enough customers to breakeven and the number and size of facilities operated by competitors. Generally, for branches designed to attract and hold deposits key factors to consider usually revolve around individual and family incomes, concentrations of retail stores and shops, older-than-average residents, and homeowners rather than renters. For branch facilities emphasizing credit services residential areas with substantial new construction activity, heavy traffic flow, and high concentrations of stores and shopping centers are typically desirable for consumer and retail loan demand, while central city office locations are often chosen as locations for commercial loan facilities.4-14. What changes are occurring in the design of, and the roles played by, branch offices Please explain why these changes are occurring.Bank branches are increasingly becoming selling platforms in which more and more fee-based services are attractively and prominently advertised in order to maximize the fee-income generating potential of each branch. Moreover, branches are becoming increasingly automated to reduce personnel and other operating costs and improve speed, efficiency, and accuracy in handling a growing service volume. Branch design has come to reflect these trends with automated facilities placed at easy access points, along with information booths to speedily direct customers to the service areas they need. Human tellers may be placed deeper inside branch facilities so that customers must pass by other service departments and conspicuous advertising in order to encourage customers to become aware of and avail themselves of other bank services.4-15. What laws and regulations affect the creation of new bank and thrift branches and the closing of existing branches What advantages and what problems can the closing of a branch office createThe opening of new branch offices must be approved by a bank's or thrift’s principal feder al or state supervisor. Closing a branch office has become much more complicated in recent years as the result of several new laws and regulations. For example, the FDIC Improvement Act requires 90 days advance notice of branch closings to both customers and the principal supervisory agency and a posting on the branch site at least 30 days prior to closing. Banks and thrifts must also make an "affirmative effort" to reach all segments of their communities without discrimination under the terms of the Community Reinvestment Act which raises the danger of customer protests against closings if it appears the bank is under-serving certain groups of customers. Finally, the Community Reinvestment Act can be used as a vehicle to prevent U.S. banks and thrifts from branching expansion when they have a poor record of serving all segments of their communities. Closing selected branch offices can reduce operating costs and divert resources from less profitable to more profitable uses. However, they risk alienating good customer relationships unless it can serve those same customers with its remaining facilities.4-16. What new and innovative sites have been selected for new branch offices in recent years Why have these sites been chosen by financial firms Do you have any ideas about other sites that you believe should be consideredRapid increases in new branches located in grocery stores, shopping centers, and inside other businesses and facilities where the public frequently gathers have helped to reduce branch construction costs and promote cross-selling of goods and financial services. Other branches have been opened in apartment complexes, senior citizen centers, and other customer-convenient locations as bankers come to realize they must adjust their service locations and service hours to conform to customer needs in an intensely competitive financial-services environment.4-17. What are POS terminals and where are they usually locatedPoint-of-sale terminals are set up to accommodate customer purchases of goods and services. These computer terminals normally are located in retail stores, gasoline stations, and similar places with a link to the banks’ own computer records. When a customer of the bank makes a purchase, the amount of the transaction is deducted from the customer's deposit account and added to the store's account. Because the customer immediately loses funds many bank customers have been hesitant to use the service as opposed to paying by check or credit card where payment is delayed for a few days. However, this depends on whether the POS terminal is an offline or online terminal. An offline terminal accumulates all transactions until the end of the day when all transactions are subtracted from a customer’s account. This type of terminal is les s costly for the bank to operate. An online terminal subtracts the transactions immediately from the customer’s account and reduces the chance of an overdraft occurring but is more expensive for the bank to operate. Consumer reluctance to use POS terminals appears to be fading and as fees for other services rise this reluctance will continue to disappear.4-18. What services do ATMs provide What are the principal limitations of ATMs as a service provider Should ATM carry fees WhyThe earliest ATMs provided a convenient mechanism for cashing checks, making deposits, and verifying checking account balances, often at hours when the full-service branch offices were closed. Today, ATMs frequently provide a wide menu of old and new services, including bill paying, transfer of funds between accounts, and the purchase of tickets for travel and entertainment. Most authorities expect ATM usage to grow rapidly as these machines offer more services and as bankers increasingly move to restrict customer access to more costly human tellers and other bank personnel, often by charging extra fees for personal service.ATMs do have some significant limitations that bankers will have to work to overcome. They break down and need to be replaced, sometimes quite frequently and annoyingly for customers, and as technology changes often become quickly outdated. Customer activity around ATMs, particularly at night, has invited criminals to steal money and injure customers, sometimes creating liability for banks. Moreover, not all customers make use of these facilities due to a preference for personalized service, fear of crime, or unfamiliarity with how the machines work. Customer education and better service pricing are two important tools that could help with these problem areas in the future. In addition, ATMs do not rank high in their ability to sell peripheral services. Some banks have found that there has been a sharp decline in their ability to sell other services. Finally, ATMs are not necessarily profitable for all banks. Because they are available 24 hours, some customers may make more frequent and smaller withdrawals from the machine than they would with a human teller, driving up the costs. In addition, these same customers will often still demand a human teller to deposit their pay check, making the bank keep both tellers and ATM machines.Whether ATM should carry a fee is rather controversial. Recently, two of the largest ATM networks have decided to let owners of ATMs charge non-customers a surcharge. Several regional have begun to charge fees as well. These fees reflect the usage of ATMs. About 85% of all ATM transactions consist of cash withdrawals and only about 10 percent represent incoming deposits. In addition, in many places, ATM usage has declined as customers pass over ATMs in favor of credit and debit cards, onsite terminals and the internet.4-19. What are self-service terminals and what advantages do they have for financial institutions and their customersSelf-service terminals include ATMs and other computer-based limited-service facilities that permit a customer to call up information about his or her account and recent transactions with the institution or information about different services that the customer might be interested in purchasing. Many are accessible 24 hours a day or are easier to get to rather than wait for the help of personnel. They can save on resources by saving on staff time. Many institutions are adding telephones and video screens so that customers with problems can dial up an employee day or night with problems. This is also saving money because they can avoid duplication of staff at each branch.4-20. What financial services are currently available from banks on the internet What problems have been encountered in trying to offer internet servicesCustomers can make payments, check on account balances, move funds between accounts and get applications for loans, deposits and other services. In addition banks can advertise on the web. Some of the problems include pro tecting customers’ privacy and heading off crime. In addition, the web does not make it easy for a bank to get to know their customers personally. The cost may also be prohibitive to some customers.4-21. How can financial firms better promote internet servicesThey need to emphasize the safety of their internet services. They need to promote their home page at every opportunity and update it frequently to keep customers’ interest. They need to survey customers about their satisfaction with the services and encourage dialogue via e-mail to resolve problems. They can also provide programs to download to act as screen savers (and advertisements) and also information about the institution and the services it provides. Problems4-1. A group of businessmen and women from the town of Mathews are considering filing an application with the state banking commission to charter a new bank. Due to a lack of current banking facilities within a 10-mile radius of the community, the organizing group estimates that the initial banking facility would cost about $ million to build along with another $700,000 in other organizing expenses and would last for about 20 years. Total revenues are projected to be $510,000 the first year, while total operating expenses are projected to reach $180,000 in year 1. Revenues are expected to increase 6 percent annually after the first year, while expenses will grow an estimated 5 percent annually after year 1. If the organizers require a minimum of a 10 percent annual rate of return on their investment of capital in the proposed new bank, are they likely to proceed with their charter application given the above estimatesYear Revenues Op Expense Net Profits1 $510,000 $180,000 $330,0002 $540,600 $189,000 $351,6003 $573,036 $198,450 $374,5864 $607,418 $208,373 $399,0465 $643,863 $218,791 $425,0726 $682,495 $229,731 $452,7647 $723,445 $241,217 $482,2288 $766,851 $253,278 $513,5739 $812,863 $265,942 $546,92110 $861,634 $279,239 $582,39511 $913,332 $293,201 $620,13112 $968,132 $307,861 $660,27113 $1,026,220 $323,254 $702,96614 $1,087,793 $339,417 $748,37715 $1,153,061 $356,388 $796,67316 $1,222,245 $374,207 $848,03817 $1,295,579 $392,917 $902,66218 $1,373,314 $412,563 $960,75119 $1,455,713 $433,191 $1,022,52220 $1,543,056 $454,851 $1,088,205Initial Investment $3,900,000Required Rate of ReturnPresent Value of Future CashFlows $4,491,642Net Present Value of Investment $591,642Given the above information, the organizers are likely to proceed given that the net present value of this investment is positive. The return they are going to earn is greater than the 10% they need to earn.4-2. Andover Savings Bank is considering the establishment of a new branch office at the corner of Lafayette and Connecticut Avenues. The savings association’s Economics Department projects annual operating revenues of $ million from services sold to generate fee income and annual branching operating expenses of $880,000. The cost of procuring the property is $ million and branch construction will total an estimated $ million; the facility is expected to last 16 years. If the savings bank has a minimum acceptable rate of return on its invested capital of 12 percent, will Andover likely proceed with this branch office projectYear Revenues Op Expenses Net Profits1 $1,750,000 $880,000 $870,0002 $1,750,000 $880,000 $870,0003 $1,750,000 $880,000 $870,0004 $1,750,000 $880,000 $870,0005 $1,750,000 $880,000 $870,0006 $1,750,000 $880,000 $870,0007 $1,750,000 $880,000 $870,0008 $1,750,000 $880,000 $870,0009 $1,750,000 $880,000 $870,00010 $1,750,000 $880,000 $870,00011 $1,750,000 $880,000 $870,00012 $1,750,000 $880,000 $870,00013 $1,750,000 $880,000 $870,00014 $1,750,000 $880,000 $870,00015 $1,750,000 $880,000 $870,00016 $1,750,000 $880,000 $870,000Initial Investment $4,820,000Required Rate of ReturnPresent Value of Future CashFlows $6,067,368Net Present Value of Investment $1,247,368Andover is likely to proceed with this project because the net present value is positive. This means that the interest rate that Andover will earn on this project is higher than the 12% they need to earn. 4-3. Jackson Bank of Commerce estimates that building a new branch office in the newly developed Guidar residential township will yield an annual expected return of 13 percent with an estimated standard deviation of 5 percent. The bank’s marketing department estimates that cash flows from the proposed Guidar branch will be mildly correlated (with a correlation coefficient of + with the bank’s other sources of cash flow. The expected annual return from the bank's existing facilities and other assets is 10 percent with a standard deviation of 3 percent. The branch will represent just 10 percent of Jackson’s total assets. Will the proposed branch increase Sullivan's overall rate of return Its overall riskThe estimated total rate of return would be:E (R) = (13%) + (10%) = %The risk attached to this overall return rate would be:Thus % and the branch will slightly increase the bank's expected return but slightly decrease its overall risk. The bank should proceed with this project.4-4. The following statistics and estimates were compiled by First Savings Bank of Talbot regarding a proposed new branch office and the bank itself:Branch Office Expected Return 16%Standard Deviation of Return = 7%Ban k’s overall expected return= 10%Standard deviation of bank’s return= 3%Branch Asset Value as a Percentof Total Bank Assets = 15%Correlation of Cash Flows = +What will happen to the Talbot’s total expected return and overall risk if the proposed new branch is adoptedThe bank's total expected return is:E (R) = (16%) + (10%) = %The bank's risk exposure is:σ=And thus .0301 or 3.01%The proposed project raises the savings banks expected return slightly and does not affect the risk of the bank. This is a good project.4-5. First National Bank of Yukon is considering installing 3 ATMs in its westside branch. The new machines are expected to cost $48,000 apiece. Installation costs will amount to about $16,000 per machine. Each machine has a projected useful life of 10 years. Due to rapid growth in the westside district these three machines are expected to handle 180,000 transactions per year. On average, each cash transaction is expected to save $ per transaction in check processing costs. If First National has a 12% cost of capital, should the bank proceed with this investment project Year Savings1 $57,600 (.32*180,000)2 $57,6003 $57,6004 $57,6005 $57,6006 $57,6007 $57,6008 $57,6009 $57,60010 $57,600Initial Investment 192000 (48,000*3+16,000*3)Required Rate of ReturnPresent Value of Future CashFlows $325,Net Present Value $133,The net present value of this project is positive. First National Bank of Yukon should add the ATM machines to the Westside.4-6. First State Security Bank is planning to set up its own web page to advertise its location and services on the Internet and to offer customers selected service options, such as paying recurring household bills, verification of account balances, and dispensing deposit account and loan application forms. What factors should First State take into account as it plans its own web page and Internet service menu How can the bank effectively differentiate itself from other banks currently present on the Internet How might the bank be able to involve its own customers in designing its web site and pricing its Internet service packageThe bank should remember that while the internet is a relatively low cost way of expanding and allows customers to find the bank rather than the bank having to find customers, there are serious concerns about privacy. In addition, the Internet is not limited by geography and while there are thousands of potential customers, there are also many financial institutions around the world competing for customer deposits and loans. The bank needs to be aware that there are many bank web pages out there and that they will need to invest in employees with the technical expertise to manage the new web site well. One of the first things the bank needs to do is to take steps to protect its customers and let its customers know what its privacy and security policies are. Another step the bank can take is to start with a customer survey to find out what its customers want and need from the bank’s Internet services. They can run this as a contest and give awa y some small items to the customer with the best ideas for the web page and Internet service. This should help get customers involved in the design and implementation of the web page and may help the bank start building an online customer base.。

Chapter 6Problems6-11. Casio Merchants and Trust Bank, N.A., has a portfolio of loans and securities expected to generate cash inflows for the bank as follows:Expected Cash Receipts Period in Which Receipts Are Expected$1,385,421 Current year746,872 Two years from today341,555 Three years from today62,482 Four years from today9,871 Five years from todayDeposits and money market borrowings are expected to require the following cash outflows:Expected Cash Payments Period in Which Payments Will be Made$1,427,886 Current year831,454 Two years from today123,897 Three years from today1,005 Four years from today----- Five years from todayIf the discount rate applicable to the above cash flows is 8 percent, what is the duration of the bank's portfolio of earning assets and of its deposits and money market borrowings? What will happen to the bank's total returns, assuming all other factors are held constant, if interest rates rise? If interest rates fall? Given the size of the duration gap you have calculated, what type of hedging should the bank engage in? Please be specific about the hedging transactions that are needed and their expected effects.Solution:Casio has an asset duration of:$1,385,421 *1 + $746,872 * 2 + $341,555 * 3 + $62,482 * 4 + $9,871 * 5(1 + 0.08)1 (1 + 0.08)2 (1 + 0.08)3 (1 + 0.O8)4 (1 + 0.O8)5D A = $1,385,421 + $746,872 + $341,555 + $62,482 + $9,871(1 + 0.08)1 (1 + 0.08)2 (1 + 0.08)3 (1 + 0.08)4 (1 + 0.08)5=$3,594,1481 / $2,246,912 = 1.5996 yearsCasio has a liability duration of:$1,427,886 * 1 + $831,454 * 2 + $123,897 * 3 + $1,005 * 4(1 + 0.08)1 (1 + 0.08)2 (1 + 0.08)3 (1 + 0.08)4D L=$1,427,886 + $831,454 + $123,897 + $1,005(1 + 0.08)1 (1 + 0.08)2 (1 + 0.08)3 (1 + 0.08)4= $3,045,808 / $2,134,047 = 1.4272 yearsCasio's Duration Gap = Asset Duration - Liability Duration = 1.5996 - 1.4272 = 0.1724 years.Because Casio's Asset Duration is greater than its Liability Duration, the bank has a positive duration gap, which means that the bank's total returns will decrease if interest rates rise because the value of the liabilities will decline by less than the value of the assets. On the other hand, if interest rates were to fall, this positive duration gap will result in the bank's total returns increasing. In this case, the value of the assets will rise by a greater amount than the value of the liabilities.Given the magnitude of the duration gap, the management of Casio Merchants and Trust Bank needs to do a combination of things to close its duration gap between assets and liabilities. It probably needs to try to shorten asset duration, lengthen liability duration, and use financial futures or options to deal with whatever asset-liability gap exists at the moment. The bank may want to consider securitization or selling some of its assets, reinvesting the cash flows in maturities that will more closely match its liabilities' maturities. The bank may also consider negotiating some interest-rate swaps to change the cash flow patterns of its liabilities to more closely match its asset maturities. Alternative Scenario 1:Given: The discount rate applicable to Casio's cash inflows and outflows falls to 6 percent. How does the duration of its earning assets and liabilities change? How does this change affect the bank's sensitivity to interest rate movements?Solution:Casio now has an asset duration of:$1,385,421 * 1 + $746,872 * 2 + $341,555 * 3 + $62,482 * 4 + $9,871 * 5(1 + 0.06)1 (1 + 0.06)2 (1 + 0.06)3 (1 + 0.06)4 (1 + 0.06)5D A =$1,385,421 + $746,872 + $341, 555 + $62,482 + $9,871(1 + 0.06)1 (1 + 0.06)2 (1 + 0.06)3 (1 + 0.06)4 (1 + 0.06)5= $3,731,603 / $2,315,358 = 1.6117 yearsCasio now has a liability duration of:$1,427,886 * 1 + $831,454 * 2 + $123,897 *3 + $1,005 * 4(1 + 0,06)1 1 + 0.06)2 (1 + 0.06)3 (1 + 0.06)4D L=$1,427,886 + $831,454 + $123,897 + $1,005(1 + 0.06)1 (1 + 0.06)2 (1 + 0.06)3 (1 + 0.06)4= $3,142,308 / $2,191,876 = 1.4336 yearsBoth the Asset Duration and the Liability Duration increase with the decline in the discount rate, with the Asset Duration increasing by more than the Liability Duration. The Duration Gap increases from 0.1724 years to 0.1781 years, making Casio more sensitive to interest rate changes.Alternative Scenario 2:Given: The appropriate discount rate climbs to 10 percent.What happens to the durations of Casio's earning assets and liabilities? How does the interest rate sensitivity of Casio's total return change as a result of this upward movement in the discount rate?Solution:Casio now has an asset duration of:$1,385,421 * 1 + $746,872 * 2 + $341,555 X 3 + $62,482 * 4 + $9,871 * 5(1 + 0.10)1 (1 + 0.10)2 (1 + 0.10)3 (1 + 0.10)4 (1 + 0.10)5D A=$1,385,421 + $746,872 + $341,555 + $62,482 + $9,871(1 + 0.10)1 (1 + 0.10)2 (1 + 0.10)3 (1 + 0.10)4 (1 + 0.10)5= $3,465,169 / $2,182,144 = 1.5880 yearsCasio now has a liability duration of:$1,427,886 * 1 + $831,454 * 2 + $123,897 * 3 + $1,005 * 4(1 + 0.10)1 (1 + 0.10)2 (1 + 0.10)3 (1 + 0.10)4D L = $1,427,886 + $831,454 + $123,897 + $1,005(1 + 0.10)1 (1 + 0.10)2 (1 + 0.10)3 (1 + 0.10)4= $2,954,385 / $2,079,002 = 1.4211 yearsThe new Duration Gap = 1.5880 – 1.4211 = 0.1669 years.With the increase in the discount rate, both the Asset Duration and the Liability Duration decrease, with the Asset Duration declining by a greater rate than the Liability Duration.The interest sensitivity of the two portfolios, and the bank as a whole, declines, due to the relative degree of change in each portfolio.6-12. Given the cash inflow and outflow figures in Problem 11 for Casio Merchants and Trust Bank, what would happen to the value of Casio's net worth as a result of thismovement in interest rates? If interest rates drop from 8 percent to 7 percent, what happens to Casio's net worth in this case and by how much in dollars does it change?From Problem #11 we find that Casio's average asset duration is 1.5996 years and average liability duration is 1.4272 years. If total assets are $125 million and total liabilities are $110 million, then Casio has a duration gap of:Duration Gap = 1.5996 – 1.4272 * mill.$125mill. $110 = 1.5996 – 1.2559= 0.3437The change in Casio's net worth would be:Change in Value of Net Worth = [-D A * r)(1r +∆* A] – [ - D L * r)(1r +∆* L]If interest rates fall from 8 percent to 7 percent,Change in NW = ⎥⎦⎤⎢⎣⎡+-⎥⎦⎤⎢⎣⎡+mill. $110x .08)(1(-.01) x 1.4272- $125x .08)(1(-.01) x 1.5996-= + 1.8514 – 1.4536 = + 0.3978 million.6-13. Leland National Bank reports an average asset duration of 4.5 years, an average liability duration of 3.25 years. The bank has total assets of $1.8 billion and liabilities totaling $1.5 billion. If interest rates rise from 7 percent to 9 percent, how will Leland's net worth change? What if interest rates fall from 7 to 5 percent?The key formula is:Change in net worth = [-D A * ∆r (1r)+* A] - [ - D L *Dr (1r)+* L]For the change in interest rates from 7 to 9 percent, Leland's net worth will change to:Change in Net Worth =⎥⎦⎤⎢⎣⎡++⎥⎦⎤⎢⎣⎡++mill. $1500x .07)(1.02)( x years 3.25- -mill. x$1800.07)(1.02)( x years 4.5-= -$151.40 million + $91.12 million= -$60.28 millionOn the other hand, if interest rates decline from 7 to 5 percent we have:Change in Net Worth =⎥⎦⎤⎢⎣⎡+⎥⎦⎤⎢⎣⎡+mill. x$1500.07)(1(-.02) x yrs 3.25--mill. x$1800.07)(1(-.02) x yrs 4.5-= + $151.40 mill. - $91.l2 mill. = + $60.28 million.6-（1）A bank holds a bond in its investment portfolio whose duration is 5.5 years. Its current market price is $950. While market interest rates are currently at 8 percent for comparable quality securities, an increase to 10 percent is expected in the coming weeks. What change (in percentage terms) will the bond’s price experience if market interest rates change as anticipated?Solution:percent 10.19-or 1019.)08.1()02(.5.5)1(-=-=+∆-≈∆x i i Dx P PThis bond’s price will decrease by 10.19 percent or its price will decline to $853.6-（2）A bank’s dollar weighted asset durati on is 6 years. Its total liabilities amount to $750 million, while its assets total $900 million. What is the dollar-weighted duration of the bank’s liability portfolio if the bank’s duration gap were zero?Given the bank has a duration gap equal to zero:Duration Gap = AssetsTotal s Liabilitie Total x D - D L Ayears 7.2 $750$900 x 0) - (6 s Liabilitie T otal Assets T otal x Gap)Duration - (D D A L ===6-（3）Commerce National Bank holds assets and liabilities whose average duration and dollar amount are shown as below:What is the dollar-weighted duration of the bank’s asset portfolio and liability portfolio? What is the duration gap?D A = years 4.35 mill.$520mill. $140 x yrs. 4.5 mill. $520mill. $320yrs.x 3.6 mill. $520mill. $60 x yrs. 8.0=++D L = years 1.061 $510$20 x yrs. 0.1 $510$490 x yrs. 1.1=+years 3.31 $520$510 x yrs. 1.061 - yrs. 4.35 Assets T otal s Liabilitie T otal x D - D Gap Duration L A ===6-.（4） A government bond currently carries a yield to maturity of 12 percent for a maturity of 5 years and a current market price of $928. The bond pays $100 in annual interest. If the bond has a par value of $1,000 its duration can be found from:D = ⎥⎦⎤⎢⎣⎡+++++++++543210.12)(1$1100x50.12)(1$100x40.12)(1$100x30.12)(1$100x20.12)(1$100x1 / $928= $928$3837.31 = 4.14 years。

CHAPTER 7ASSET—LIABILITY MANAGEMENT： DETERMINING AND MEASURING INTEREST RATES AND CONTROLLING INTEREST-SENSITIVE AND DURATIONGAPSGoals of This Chapter： The purpose of this chapter is to explore the options bankers have today for dealing with risk – especially the risk of loss due to changing interest rates – and to see how a bank’s management can coordinate the management of its assets with the management of its liabilities in order to achieve the institution’s goals。

Key Topic In This Chapter•Asset， Liability, and Funds Management•Market Rates and Interest Rate Risk•The Goals of Interest Rate Hedging•Interest Sensitive Gap Management•Duration Gap Management•Limitations of Hedging TechniquesChapter OutlineI. Introduction: The Necessity for Coordinating Bank Asset and Liability ManagementDecisionsII。

Asset/Liability Management StrategiesA. Asset Management StrategyB。

CHAPTER 9RISK MANAGEMENT USING ASSET-BACKED SECURITIES, LOAN SALES, CREDITSTANDBYS, AND CREDIT DERIVATIVESGoal of This Chapter: The purpose of this chapter is to learn about some of the newer financial instruments that financial institutions have used in recent years to help reduce the risk exposure of their institutions and, in some cases, to aid in generating new sources of fee income and in raising new funds to make loans and investments.Key Topics in This Chapter•The Securitization Process•Securiti zation’s Impact and Risks•Sales of Loans: Nature and Risks•Standby Credits: Pricing and Risks•Credit Derivatives and CDOs•Benefits and Risks of Credit DerivativesChapter OutlineI. IntroductionII. Securitizing Bank Loans and Other AssetsA. Nature of SecuritizationB. The Securitization ProcessC. Advantages of SecuritizationD. The Beginnings of Securitization – The Home Mortgage Market1. Collateralized Mortgage Obligations – CMOs2. Loan Backed BondsE. Examples of Other Assets That Have Been SecuritizedF. The Impact of Securitization Upon Lending InstitutionsG. Regulators’ Concerns About SecuritizationIll. Sales of Loans to Raise FundsA. Nature of Loan SalesB. Loan Participations and Loan StripsC. Reasons Behind Loan SalesD. The Risks in Loan SalesIV. Standby Credit LettersA. The Nature of Standby Credits (Contingent Obligations)B. Types of Standby Credit LettersC. Advantages of StandbysD. Reasons for Rapid Growth of StandbysE. The Structure of Standby Letters of CreditF. The Value and Pricing of Standby LettersG. Sources of Risk with Standby CreditsH. Regulatory Concerns about Standby Credit ArrangementsI. Research Studies on Standbys, Loan Sales, and SecuritizationsV. Credit Derivatives: Contracts for Reducing Credit Risk Exposure on the Balance SheetA. An Alternative to SecuritizationB. Credit SwapsC. Credit OptionsD. Credit Default SwapsE. Credit Linked NotesF. Collateralized Debt ObligationsG. Risks Associated With Credit DerivativesVI. Summary of the ChapterConcept Checks9-1. What does securitization of assets meanSecuritization involves the pooling of groups of earning assets, removing those pooled assets from the bank’s balance sheet, and issuing securities against the pool. As the pooled assets generate interest income and repayments of principal the cash generated by the pooled earning assets flows through to investors who purchased those securities.9-2. What kinds of assets are most amenable to the securitization processThe best types of assets to pool are high quality, fairly uniform loans, such as home mortgages or credit card receivables.9-3. What advantages does securitization offer lending institutionsSecuritization gives lending institutions the opportunity to use their assets as sources of funds and, in particular, to remove lower-yielding assets from the balance sheet to be replaced withhigher-yielding assets.9-4. What risks of securitization should the managers of lending institutions be aware of Lending institutions often have to use the highest-quality assets in the securitization process which means the remainder of the portfolio may become more risky, on average, increasing the bank’s capital requirements.9-5. Suppose that a bank securitizes a package of its loans that bear a gross annual interest yield of 13 percent. The securities issued against the loan package promise interested investors an annualized yield of 8.25 percent. The expected default rate on the packaged loans is 3.5 percent. The bank agrees to pay an annual fee of 0.35 percent to a security dealer to cover the cost of underwriting and advisory services and a fee of 0.25 percent to Arunson Mortgage Servicing Corporation to process the expected payments generated by the packaged loans. If the above items represent all the costs associated with this securitization transaction can you calculate the percentage amount of residual income the bank expects to earn from this particular transaction The bank’s estimated residual income should be about:Gross Loan Security Expected Default On Underwriting Yield - Interest Rate - Packaged Loans - And Advisory Fee13% 8.25% 3.5% .35%Servicing Expected- Fee = Residual Income.25% .65%9-6. What advantages do sales of loans have for lending institutions trying to raise funds Loan sales permit a lending institution to get rid of less desirable or lower-yielding loans and allow them to raise additional funds. In addition, replacing loans that are sold with marketable securities can increase the liquidity of the lending institution.9-7. Are there any disadvantages to using loan sales as a significant source of funding for banks and other financial institutionsThe lender may find themselves selling off their highest quality loans, leaving their loan portfolio stocked with poor-quality loans which can trigger the attention of regulators who might require higher capital requirements for the lender. .9-8. What is loan servicingLoan servicing involves monitoring borrower compliance with a loan’s terms, collecting an d recording loan payments, and reporting to the current holder of the loan.9-9. How can loan servicing be used to increase incomeMany banks have retained servicing rights on the loans they have sold, earning fees from the current owners of those loans.9-10. What are standby credit letters Why have they grown so rapidly in recent years Standby credit letters are promises of a lender to pay off an obligation of one of its customers in case that customer cannot pay. It can also be a guarantee that a project of customer is completed on time. There are several reasons that standby credit agreements have grown. There has been a tremendous growth in direct financing by companies (issuance of commercial paper) and with growing concerns about default risk on these direct obligations banks have been asked to provide a credit guarantee. Another reason for their growth is the ability of the bank to use their skills to add fee income to the bank Another reason is that these have a relatively low cost for the bank. Finally banks and customers perceive that there has been an increase in economic fluctuations and there has been increased demand for risk reducing devices.9-11. Who are the principal parties to a standby credit agreementThe principal parties to a standby credit agreement are the issuing bank or other institution, the account party who requested the letter, and the beneficiary who will receive payment from the issuing institution if the account party cannot meet its obligation.9-12. What risks accompany a standby credit letter for (a) the issuer and (b) the beneficiary Standbys present the issuer with the danger that the customer whose credit the issuer has backstopped with the letter will need a loan. That i s, the issuer’s contingent obligation will become an actual liability, due and payable. This may cause a liquidity squeeze for the issuer. The beneficiary that has to collect on the letter must be sure it meets all the conditions required for presentation of the letter or it will not be able to recover its funds.9-13 How can a lending institutions mitigate the risks inherent in issuing standby credit letters They can use various devices to reduce risk exposure from the standby credit letters they have issued, such as:1. Frequently renegotiating the terms of any loans extended to customers who havestandby credit guarantees so that loan terms are continually adjusted to thecustomers’ changing circumstances and there is less need for the beneficiaries o fthose guarantees to press for collection.2. Diversifying standby letters issued by region and by industry to avoidconcentration of risk exposure.3. Selling participations in standbys in order to share risk with a variety of lendinginstitutions.9-14. Why were credit derivatives developed What advantages do they have over loan sales and securitizations, if anyCredit derivatives were developed because not all loans can be pooled. In order to be pooled, the group of loans has to have common features such as maturities and cash flow patterns and many business loans do not have those common features. Credit derivatives can offer the beneficiary protection in the case of loan default and may help the bank reduce its credit risk and possibly its interest rate risk as well.9-15. What is a credit swap For what kinds of situations was it developedA credit swap is where two lenders agree to swap portions of their customer’s loan repayments. It was developed so that banks do not have to rely on one narrow market area. They can spread out the risk in the portfolio over a larger market area.9-16. What is a total return swap What advantages does it offer the swap beneficiary institution A total return swap is a type of credit swap where the dealer guarantees the swap parties a specific rate of return on their credit assets. A total return swap can allow a bank to earn a more stable rate of return than it could earn on its loans. This type of arrangement can also shift the credit risk and the interest rate risk from one bank to another.9-17. How do credit options work What circumstances result in the option contract paying off A credit option helps guard against losses in the value of a credit asset or helps offset higher borrowing costs. A bank which purchases a credit option contract will exercise their option if the asset declines significantly in value or loses its value completely. If the assets are paid off as expected then the option will not be exercised and the bank will lose the premium they paid for the option. A bank can also purchase a credit option which will be exercised if their borrowing costs rise above a specified spread between their cost and a riskless asset.9-18. When is a credit default swap useful WhyA credit default swap is a credit option written on a portfolio of assets or a credit swap on a particular loan where the other bank in the swap agrees to pay the first bank a certain fee if the loan defaults. This type of arrangement is designed for banks that can handle relatively small losses but want to protect themselves from serious losses.9-19. Of what use are credit-linked notesA credit-linked note allows the issuer of a note to lower the coupon payments if some significant fact changes. For example, if more loans on which the notes are based default than expected, the coupon payments on the notes can be lowered. The lender has taken on credit-related insurance from the investors who have purchased the note.9-20. What are CDOs How do they differ from other credit derivativesA CDO is very similar to loan securitization, where the pool of assets can include high yield bonds, equities and other financial instruments, which are generally of higher risk than in the traditional loan securitization.9-21. What risks do credit derivatives pose financial institutions using them In your opinion what should regulators do about the recent rapid growth of this market, if anythingThere are several risks associated with these instruments. One risk is that the other party in the swap or option may fail to meet their obligation. Courts may rule that these instruments are illegal or improperly drawn. These types of instruments are relatively new and the markets for these instruments are relatively thin. If a bank needs to resell one of these contracts they may have difficulty finding a buyer or they may not be able to sell it at a reasonable price. Regulators need to understand clearly the benefits and risks of these types of credit instruments and act to ensure the safety of the banks.Problems9-1. Giant National Bank has placed a group of 10,000 consumer loans bearing an average expected gross annual yield of 8 percent in a package to be securitized. The investment bank advising Giant estimates that the securities will sell at a slight discount from par that results in a net interest cost to the issuer of 9 percent. Based on recent experience with similar types of loans, the bank expects 3 percent of the packaged loans to default without any recovery for the lender and has agreed to set aside a cash reserve to cover this anticipated loss. Underwriting and advisory services provided by the investment banking firm will cost .5 percent. Giant will also seek a liquidity facility, costing .5 percent and a credit guarantee if actual loans should exceed the expected loan default rate, costing .6 percent. Please calculate the residual income for Giant from this loan securitization.The estimated residual income for Giant National Bank is:Gross Loan Security Expected Default On Underwriting Yield - Interest Rate - Packaged Loans - And Advisory Fee8% 9% 3% .5%Liquidity FacilityCreditEnhancementExpected- Fee - Fee = Residual Income .5% .6% -5.6%9-2. Colburn Corporation is requesting a loan for repair of some assembly-line equipment in the amount of $7 million. The nine-month loan is priced by Farmers Financial Corporation at a 7.25 percent rate of interest. However, the finance company tells Colburn that if it obtains a suitable credit guarantee the loan will be priced at percent. Quinmark Bank agrees to sell Colburn a standby credit guarantee for $10,000. Is Colburn likely to buy the standby credit agreement Please explain.The interest savings from having the credit guarantee would be:[$7 mill. * 0.0725 * ?] - [$7 mill. x 0.0700 * ?] =$380,625 - $367,500 = $13,125Clearly, the $10,000 guarantee is priced correctly and will be purchased.9-3. The Monarch Bank Corp. has placed $100 million of GNMA-guaranteed securities in a trust account off the balance sheet. A CMO with four tranches has just been issued by Monarch using the GNMAs as collateral. Each tranche has a face value of $25 million and makes monthly payments. The annual coupon rates are 4 percent for Tranche A, 5 percent for Tranche B, 6 percent for Tranche C, and 7 percent for Tranche D.a. Which tranche has the shortest maturity and which tranche has the mostprepayment protectionTranche A has the shortest maturity and tranche D has the most prepayment protection.b. Every month principal and interest are paid on the outstanding mortgages and somemortgages are paid in full. These payments are passed through to Monarch and thetrustee uses the funds to pay the coupons to CMO bondholders. What are thecoupon payments owed for each tranche for the first monthTranche A: 25 million x (.04/12) = $83,333Tranche B: 25 million x (.05/12) = $104,177Tranche C: 25 million x (.06/12) = $125,000Tranche D: 25 million x (.07/12) = $145,833c. If scheduled mortgage payments and early prepayments bring in $1 million, howmuch will be used to retire the principal of CMO bondholders and which tranchewill be affectedTotal interest to be paid: $83,333 + $104,177 + $125,000 + $145,833 = $458,343Amount applied to principal: $1,000,000 - $458,343 = $541,657Tranche A will be affected by the reduction in principal.d. Why does Tranche D have a higher expected returnTranche D has the longest maturity and the highest reinvestment risk and thus, should have the highest expected return. In addition, since prepayments are first applied to the othertranches, tranche D also carries the highest amount of default risk.9-4. First Security National Bank has been approached by a long standing customer, United Safeco Industries, for a $30 million term loan request for five years to purchase new stamping machines that would further automate the company’s assembly line in the manufacture of metal toys and containers. The company also plans to use at least half the loan proceeds to facilitate its buyout of Calem Corporation which imports and partially assembles video recorders and cameras. Additional funds for the buyout will come from a corporate bond that will be underwritten by an investment banking firm not affiliated with First Security.The problem the bank’s commercial credit division faces in assessing the customer loan request is a management decision reached several weeks ago that the bank should gradually work down its leverage buyout loan portfolio due to a significant rise in nonperforming credits.Moreover, the prospect of sharply higher interest rates has caused the bank to revamp its loan policy toward more short term loans (under one year) and fewer term (over one year) loans. Senior management has indicated it will no longer approve loans that require a commitment of the bank’s resources beyond a term of three years, except in special cases.Does the bank have any service option in the form of off-balance-sheet instruments that could help this customer while avoiding committing $30 million in reserves for a five-year loan What would you recommend that management do to keep United Safeco happy with its current banking relationship Could the bank earn any fee income if it pursued your idea Suppose the current interest rate on Eurodollar deposits (three month maturities) in London is 8.4 percent, while Federal funds and six-month CDs are trading in the United States at 8.55 percent and 8.21 percent, respectively. Term loans to comparable-quality corporate borrowers are trading at 1/8 to ? percentage point above the three-month Eurodollar rate and ? to ? point over the secondary-market CD rate. Is there a way that First Security could earn at least as much fee income by providing United Safeco with support services as it could from making the loan United Safeco has asked for (after all loan costs are taken into account) Please explain how the customer could benefit even if the bank does not make the loan requested.In view of these reasonable objectives on the part of First Security National Bank’s management, the bank should consider recommending that the leveraged buy-out portion of the request be handled by an offering of bonds or, perhaps, 5-year notes, with the bank issuing a standby letter of credit for a portion (though probably not all) of the bond or note issue. Armed with First Security’s standby credit agreement, United Safeco should be able to borrow through a security issue at a substantially lower interest rate. First Security could sell participations in the standby credit to share its risk exposure.For the portion of the loan that calls for the purchase of new assembly-line equipment, management might seriously consider proposing a shorter-term loan for about one-third toone-half the total amount requested by Safeco. This loan would be secured by a pledge of the new equipment plus sufficient covenants to insure the maintenance of adequate liquidity and require bank approval before significant amounts of other forms of debt are undertaken.First Security could generate fee income from this relationship by assessing a fee for issuing the standby letter of credit. The fee for a standby letter of credit typically ranges from ? percent to 1 percent of the amount of the st andby guarantee, depending upon the bank’s assessment of the degree of risk exposure in the guarantee.If First Security issues a standby letter of credit on behalf of United Safeco as described above, both parties should benefit. First Security, by issuing the standby credit agreement, does not have to tie up $30 million in reserves for an extended period of time as it would if it made the requested loan, particularly in a projected rising interest rate environment. The ? percent to 1 percent fee would compare favorably in amount to the 1/8 to ? percent spread over the Eurodollar rate or the ? to ? percent spread over the federal funds or CD rate that currently prevails in the market. Under the risk-based capital standards now in effect, the standby letter of credit will require the bank to hold capital in an amount equal to the capital requirement for the loan. Therefore, United Security National will have the same capital requirement for either transaction, the loan or the standby letter of credit.Also, as stated above, United Safeco should be able to issue bonds or notes at a more favorable rate with United Security National’s standby letter of credit behind them.9-5. What type of credit derivatives contract would you recommend for each of the following situations:a. A bank plans to issue a group of bonds backed by a pool of credit card loans but fears thatthe default rate on these credit card loans will rise well above 6 percent of the portfolio –the default rate it has projected. The bank wants to lower the interest costs on the bonds in case the loan default rate is too high.The best solution to this problem is to use credit linked notes. The interest payments on these notes will change if significant factors change.b. A commercial finance company is about to make a $50 million project loan to develop anew gas field and is concerned about the risks involved if petroleum geologists’ estimates of the field’s potential yield turn out to be much too high and the field developer cannot repay.One possibility for solving this problem is to use a credit option. If the developer cannot repay the loan then the option would pay off. They would lose their premium if thedeveloper can repay the loan but they are protected against significant loss.c. A bank holding company plans to offer new bonds in the open market next month, butknows that the company’s credit rating is being reevaluated by credit-rating agencies. The holding company wants to avoid paying sharply higher credit costs if its rating is lowered by the investigating credit-rating agencies.A credit risk option would be a good solution to this problem because it protects the bankfrom higher borrowing costs in the future. If the borrowing costs rise above the spreadspecified in the option contract, the contract would pay off.d. A mortgage company is concerned about possible excess volatility in its cash flow off a recently made group of commercial real estate loans supporting the building of several apartment complexes. Moreover, many of these loans were made at fixed interest rates, and the company’s economics department has forecast a substantial rise in capital market interest rates. The company’s management would prefer a more stable cash flow emerging from this group of loans if it could find a way to achieve it.One possibility to solve this problem would be to enter into a total return swap with another bank. The other bank would receive total payments of interest and principal on this loan as well as the price appreciation on this loan. The original bank would receive LIBOR plus some spread in return as well as compensation for any depreciation in value of the loan.e. First National Bank of Ashton serves a relatively limited geographic area centered around a moderate-sized metropolitan area. It would like to diversify its loan income but does not wish to make loans in these other market areas due to its lack of familiarity with loan markets outside the region it has served for many years. Is there a derivative contract that could help the bank achieve the loan portfolio diversification it seeksThis bank could enter into a credit swap with another bank. This swap agreement means that the two banks simply exchange a portion of their customers’ loan repayments. The purpose of this type of swap agreement is to help the two banks diversify their market area with having to make loans in an unfamiliar area.。

CHAPTER 6ASSET/LIABILITY MANAGEMENT: DETERMINING AND MEASURING INTEREST RATES AND CONTROLLING A BANK’S INTEREST-SENSITIVE GAP Goals of This Chapter: To learn how to measure a bank's exposure to interest-rate risk and how to reduce that risk exposure through coordinated management of bank assets and liabilities.Key Terms Presented In This ChapterAsset-liability Management Yield to Maturity (YTM)Asset Management Bank Discount RateLiability Management Net Interest MarginFunds Management Interest-Sensitive Gap ManagementInterest Rate RiskChapter OutlineI. Introduction: The Necessity for Coordinating Bank Asset and Liability ManagementDecisionsII. Asset/Liability Management StrategiesA. Asset Management StrategyB. Liability Management StrategyC. Funds Management StrategyIll. Interest Rate Risk: One of the Banker's Greatest ChallengesA. Nature of Interest-Rate RiskB. Forces Determining Interest RatesC. The Measurement of Interest Rates1. Yield to Maturity2. Bank Discount RateD. The Components of Interest RatesE. Bankers' Response to Interest Rate RiskIV. One of the Goals of Interest-Rate HedgingA. The Net Interest MarginB. Interest-Sensitive Gap Management1. Asset-Sensitive Position2. Liability-Sensitive Position3. Calculation of a Bank's Interest-Sensitive Gap4. Impact of Changing Interest Rates on the Gap5. Decisions that need to be Made Concerning Gap Management6. Computer Techniques for Managing Gap7. Cumulative Gap8. Strategies in Gap Management9. Limitations of Interest-Sensitive Gap Management10. Weighted Interest-Sensitive GapV. Summary of the ChapterConcept Checks6-1. What do the following terms mean: Asset management? Liability management? Funds management?Asset management refers to a banking strategy where management has control over the allocation of bank assets but believes the bank's sources of funds (principally deposits) are outside its control. Liability management is a strategy of control over bank liabilities by varying interest rates offered on borrowed funds. Funds management combines both asset and liability management approaches into a balanced liquidity management strategy.6-2. What factors have motivated banks to develop funds management techniques in recent years?The necessity to find new sources of funds in the 1970s and the risk management problems encountered with troubled loans and volatile interest rates in the 1970s and 1980s led to the concept of planning and control over both sides of a bank's balance sheet -- the essence of funds management.6-3. What forces cause interest rates to change? What kinds of risk do bankers face when interest rates change?Interest rates are determined, not by individual banks, but by the collective borrowing and lending decisions of thousands of participants in the money and capital markets. They are also impacted by changing perceptions of risk by participants in the money and capital markets, especially the risk of borrower default, liquidity risk, price risk, reinvestment risk, inflation risk, term or maturity risk, marketability risk, and call risk.Bankers can lose income or value no matter which way interest rates go. Rising interest rates can lead to losses on bank security instruments and on fixed-rate loans as the market values of these instruments fall. Falling interest rates will usually result in capital gains on fixed-rate securities and loans but a bank will lose income if it has more rate-sensitive assets than liabilities. Rising interest rates will also cause a loss to bank income if a bank has more rate-sensitive liabilities than rate-sensitive assets.6-4. What makes it so difficult for banks to forecast interest rate changes?Interest rates cannot be set by an individual bank or even by a group of banks; they are determined by thousands of investors trading in the credit markets. Moreover, each market rate of interest has multiple components--the risk-free interest rate plus various risk premia. A change in any of these rate components can cause interest rates to change. To consistently forecast market interest rates correctly would require bankers to correctly anticipate changes in the risk-free interest rate and in all rate components. Another important factor is the timing of the changes. To be able to take full advantage of their predictions, they also need to know when the changes will take place.6-5. What is the yield curve and why is it important for bankers to know about its shape or slope?The yield curve is a graphical description of the distribution of market interest rates by maturity of financial instrument. The slope of the yield curve determines the spread between long-term and short-term interest rates. In banking most of the long-term rates apply to loans and securities (i.e., bank assets) and most of the short-term interest rates are attached to bank deposits and money market borrowings. Thus, the shape or slope of the yield curve has a profound influence on a bank's net interest margin or spread between asset revenues and liability costs.6-6. What is it that a bank wishes to protect from adverse movements in interest rates?A bank wishes to protect both the value of bank assets and liabilities and the revenues and costs generated by both assets and liabilities from adverse movements in interest rates.6-7. What is the goal of hedging in banking?The goal of hedging in banking is to freeze the spread between asset returns and liability costs and to offset declining values on certain assets by profitable transactions so that a target rate of return is assured.6-8. First National Bank of Bannerville has posted the following financial statement entries: Interest revenues $63 millionInterest costs $42 millionTotal earning assets $700 millionThe bank's net interest margin must be:Net Interest = $63 mill. - $42 mill. = 0.03 or 3 percentMargin $700 mill.If interest revenues and interest costs double while earning assets grow by 50 percent, the net interest margin will change as follows:($63 mill. - $42 mill.) * 2 = 0.04 or 4 percent$700 mill. * (1.50)Clearly the net interest margin increases--in this case by one third.6-9. Can you explain the concept of gap management?Gap management involves determining the maturity distribution and the repricing schedule for a bank's assets and liabilities. When more assets are subject to repricing or will reach maturity in a given period than liabilities or vice versa, the bank has a GAP and is exposed to loss from adverse interest-rate movements based on the gap's size.6-10 When is a bank asset sensitive? Liability sensitive?A bank is asset sensitive when it has more interest-rate sensitive assets maturing or subject to repricing during a specific time period than rate-sensitive liabilities. A liability sensitive position, in contrast, would find the bank having more interest-rate sensitive deposits and other liabilities than rate-sensitive assets for a particular planning period.6-11. Commerce National Bank reports interest-sensitive assets of $870 million andinterest-sensitive liabilities of $625 million. Because interest-sensitive assets are larger than liabilities by $245 million the bank is asset sensitive.If interest rates rise, the bank's net interest margin should rise as asset revenues increase by more than the resulting increase in liability costs. On the other hand, if interest rates fall, the bank's net interest margin will fall as asset revenues decline faster than liability costs.6-12. First National Bank has a cumulative gap for the coming year of + $135 million and interest rates are expected to fall by two and a half percentage points. What is the expected change in First National's net interest income?ExpectedChange in = $135 million * (-0.025) = -$3.38 millionNet Interest IncomeWhat change will occur in net interest income if interest rates rise by one and a quarter percentage points?Expected Changein Net Interest = $135 million * (+0.0125) = +$1.69 millionIncome6-13 How do you measure a bank’s dollar interest-sensitive gap? Its relative interest-sensitive gap? What is the interest-sensitivity ratio?The dollar interest-sensitive gap is measured by taking the repriceable (interest-sensitive) assets minus the repriceable (interest-sensitive) liabilitiies over some set planning period. Common planning periods include 3 months, 6 months and 1 year. The relative interest-sensitive gap is the dollar interest-sensitive gap divided by some measure of bank size (often total assets). The interest-sensitivity ratio is just the ratio of interest-sensitive assets to interest sensitive liabilities. Regardless of which measure you use, the results should be consistent. If you find a positive (negative) gap for dollar interest-sensitive gap, you should also find a positive (negative) relative interest-sensitive gap and a interest sensitivity ratio greater (less) than one.6-14 Suppose Carroll Bank and Trust reports interest-sensitive assets of $570 million and interest-sensitive liabilities of $685 million. What is the bank’s dollar interest-sensitive gap? Its relative interest-sensitive gap and interest-sensitivity ratio?Dollar Interest-Sensitive Gap = Interest-Sensitive Assets – Interest Sensitive Liabilities= $570 - $685 = -$115Relative Gap = $ IS Gap = -$115 = -0.2018 or -20.18 percent Bank Size $570Interest-Sensitivity = Interest-Sensitive Assets =$570 = .8321 Ratio Interest-Sensitive Liabilities $6856-15 Explain the concept of weighted interest-sensitive gap. How can this concept aid bank’s real interest-sensitive gap risk exposure?Weighted interest-sensitive gap is based on the idea that not all interest rates change at the same speed. Some are more sensitive than others. Interest rates on bank assets may change more slowly than interest rates on liabilities and both of these may change at a different speed than thoseinterest rates determined in the open market. In, the weighted interest-sensitive gap methodology all interest-sensitive assets and liabilities are given a weight based on their speed (sensitivity) relative to some market interest rate. Fed Funds loans, for example, have an interest rate which is determined in the market and which would have a weight of 1. All other loans, investments and deposits would have a weight based on their speed relative to the Fed Funds rate. To determine the interest-sensitive gap, the dollar amount of each type of asset or liability would be multiplied by its weight and added to the rest of the interest-sensitive assets or liabilities. Once the weighted total of the assets and liabilities is determined, a weighted interest-sensitive gap can be determined by subtracting the interest-sensitive liabilities from the interest-sensitive assets. This weighted interest-sensitive gap should be more accurate than the unweighted interest-sensitive gap. The interest-sensitive gap may change from negative to positive or vice versa and may change significantly the interest rate strategy pursued by the bank.Problems6-1. A government bond is currently selling for $900 and pays $80 per year in interest for 5 years when it matures. If the redemption value of this bond is $1,000, what is its yield to maturity if purchased today for $900. The yield to maturity equation for this bond would be:$900 = $80(1YTM)1+ + $80(1YTM)2+ + $80(1YTM)3+ + $80(1YTM)4++ $80(1YTM)5+ + $1,000(1YTM)5+At an YTM of 10 percent the bond's price is $924.28, while at 12 percent its price becomes $864.40. Thus, the true YTM lies between 10% and 12%. To find the true YTM we use: 10% + 40.864$28.924$900$28.924$-- * 2% ≈ 10.81%6-2. Suppose the government bond described in problem #1 is held for 3 years and then the bank acquiring the bond decides to sell it at a price of $950. Can you figure out the average annual yield the bank will have earned for its 3-year investment in the bond?In this instance the yield-to-maturity equation can be modified slightly to find the correct holding-period yield that the bank would earn. Specifically,$900 = $80(1HPY)1+ + $80(1HPY)2++ $80(1HPY)3+ + $950(1HPY)3+At an HPY of 10% the bond's price becomes $912.31, while at 12% the bond's price is $868.56.The true holding period yield must be:10% + 912.31900912.31868.56--⎡⎣⎢⎤⎦⎥ x 2% ≈10.56%.6-3. U.S. Treasury bills are available for purchase this week at the following prices (based upon $100 par value) and with the indicated maturities:a. $97.25, 182 days.b. $96.50, 270 days.c. $98.75, 91 days.The discount rates and equivalent yields to maturity (bond-equivalent or coupon-equivalent yields) on each of these Treasury bills are:Discount Rates Equivalent Yields to Maturitya.(10097.25)100- * 360182 = 5.44% (365x.0544)[360(0.0544x182)]- = 19.856350.1 = 5.67% b.(10096.50)100- * 360270 = 4.67% (365x.0467)[360(.0467x270)]- = 17.046347.39 = 4.91% c. (10098.75)100- * 36091 = 4.95% (365x.0495)[360(.0495x91)]- = 18.07355.5 = 5.08%6-4. The First State Bank of Ashfork reports a net interest margin of 3.25 percent in its most recent financial report with total interest revenues of $88 million and total interest costs of $72 million. What volume of earning assets must the bank hold?The relevant formula is:Net Interest Margin = .0325 = AssetsEarning mil. $72mill. $88-Then Earning Assets = $492.31 million.Suppose the bank's interest revenues rise by 8 percent and its interest costs and earning assets increase 10 percent. What will happen to Ash Fork's net interest margin?Substituting in the correct formula we have:New Net Interest Margin = .10)million(1 $492.3.10)million(1 $72.08)(1 million $88++-+= million$541.53million $79.20million $95.04-= 0.0293 or 2.93 percent.6-5. If a bank's net interest margin, which was 2.85 percent, doubles and its total assets, which stood originally at $545 million, rise by 40 percent, what change will occur in the bank's net interest income?The correct formula is:.0285 * 2 = .4)(1*million 545$Income Interest Net +or Net Interest Income = 0.057 * $763 million= $43.49 million.6-6. The cumulative interest-rate gap of Snidal State Bank and Trust Company doubles from an initial figure of -$35 million. If market interest rates fall by 25 percent from an initial level of 6 percent, what change will occur in Snidal Bank's net interest income?The key formula here is:Change in the Bank's = Change in interest rates (in percentage points) * cumulative gap Net Interest = 0.06 * -.25 x (-$35 mill.) * 2Income = 1.05Thus, the bank's net interest income will rise by 5 percent.6-7. Given: Merchants State Bank has recorded the following financial data for the past three years (dollars in millions):Current Year Previous Year Two Years Ago Interest revenues $57 $56 $55 Interest expenses 49 42 34 Loans (Excluding nonperforming) 411 408 406 Investments 239 197 174 Total deposits 487 472 467 Money market borrowings 143 118 96 Solution:Net interest margin (NIM) = Net Interest Income/Earning Assets, whereNet Interest Income = Net Interest Revenues - Net Interest ExpensesEarning Assets = Loans + InvestmentsNIM(Current) = ($57-49)/(411 + 239) = 8/650 = 0.0123 or 1.23%NIM(previous) = ($56-42)/(408 + 197) = 14/605 = 0.0231 or 2.31%NIM(Two years ago) = ($55-34)/(406 + 174) = 21/580 = 0.0362 or 3.62%The net interest margin has been declining steadily and significantly. Probable causes include greater increases in interest expenses relative to interest income due to shifts in funding mix with greater dependence on borrowed funds (more expensive sources) relative to deposits (less expensive sources). Additionally, the mix in earning assets, with greater growth in lower yielding investment securities than in higher yielding loans, is another contributor to the steadily declining net interest margin.Management needs to reevaluate its funding strategies and its loan and investment strategies. If slower loan growth is related to external forces -- for example, a weaker economy -- then less borrowing should be considered. If the slower loan growth is more internal, then more aggressive loan management would be appropriate.6-8 The First National Bank of Wedora, California has the following interest-sensitive gaps:Coming WeekNext30 DaysNext31-90 DaysMore Than90 DaysInterest - $144 $110 $164 $184 Sensitive +29 +19 29 8 Assets = $173 $129 $193 $192 Interest - $232 $ --- $ --- $ --- Sensitive 98 84 196 35 Liabilities = 36 6 --- ---$366 $90 $196 $35 GAP - $193 + $39 - $3 + $157 Cumulative GAP - $193 - $154 - $157 $0First National has a cumulative zero gap and therefore is not vulnerable to loss if interest rates rise. It does have a positive gap in two periods--the next 30 days and more than 90 days. During these particular periods a rise in interest rates would produce a short-run gain.6-9 First National Bank of Barnett currently has the following interest-sensitive assets and liabilities on its balance sheet:Interest-Sensitive Assets Interest-Sensitive LiabilitiesFederal fund loans $65Security holdings $42 Interest-bearing deposits $185Loans and leases $230 Money-market borrowings $78What is the bank’s current interest-sensitive gap? Suppose its Federal funds loans carry an interest-rate sensitivity weight of 1.0 while its investments have a rate-sensitivity weight of 1.15 and its loans and leases display a rate-sensitivity weight of 1.35. On the liability side First National’s rate-sensitivity weight is 0.79 for interest-bearing deposits and 0.98 for itsmoney-market borrowings. Adjusted for these various interest-rate sensitivity weights, what is the bank’s weighted interest-sensitive gap? Suppose the Federal funds interest rate increases or decreases one percentage point. How will the bank’s net interest income be affecte d (a) given its current balance sheet make up and (b) reflecting its weighted balance sheet adjusted for the foregoing rate-sensitivity weights?Solution:Dollar IS Gap = ISA - ISL = ($65 + $42 + $230) - ($185 + $78) = $337 - $263 = $74 Weighted IS Gap = [(1)($65) + (1.15)(42) + (1.35)(230)] - [(.79)($185) + (.98)($78)] = $65 + $48.3 + $310.5 - $146.15 + $76.44= $423.8 - $222.59= $201.21a.) Change in Bank’s Income = IS Gap * Change in interest rates= ($74)(.01) = $.74 millionUsing the regular IS Gap, net income will change by plus or minus $740,000b.) Change in Bank’s Income = Weighted IS Gap * Change in interest rates= ($201.21)(.01) = $2.012Using the weighted IS Gap, net income will change by plus or minus $2,012,0006-10 McGraw Bank and Trust has interest-sensitive assets of $225 million and interest-sensitive liabilities of $168 million. What is the bank’s dollar interest-sensitive gap? What is McGraw’srelative interest-sensitive gap? What is the value of its interest-sensitivity ratio? Is the bank asset sensitive or liability sensitive? Under what scenario for market interest rates will the bank experience a gain in net interest income? A loss in net interest income?Dollar Interest-Sensitive Gap = ISA – ISL = $225 - $168 = $57Relative Interest-Sensitive Gap = ISA – ISL = $57 = 0.2533Bank Size $225Interest-Sensitivity Ratio = ISA = $225 = 1.3393ISL $168This bank is asset sensitive. More assets will be repriced during this time period than liabilities. This means that if interest rates rise, the interest earned on assets will rise relative to the interest paid on liabilities and net interest margin will rise. However, if interest rates fall, interest earned on assets will fall more than interest paid on liabilities and net interest margin will fall.Web Site Problems1. Suppose you want to know what types of banks make the greatest use of asset-liability management tools and what their biggest ALM problems are? Where would you go on the web to try to get answers to these questions?Almost all banks are required by regulators to have some kind of ALM management in place. These techniques can be as simple as the interest sensitive gap discussion in this chapter or the duration gap management in the next chapter. However, there are many consulting firms out there that have developed specific models for managing ALM. One way to see what is out there is to do a search on bank ALM management and see some of the sites that are out there. These sites range from sites for the consulting firms to more general sites that provide a good definition and description of ALM management. Two sources that are available at this time for general information on asset-liability management are/glossaryassetliabilitymanagement.htm and/Products/nccb_asset.htm. However if you want a good discussion of specific models and the problems people are having with ALM management, one good source appears to be /. This site has several discussion groups on various ALM topics.2. If a new web model to apply ALM techniques to a bank’s risk exposure is developed, at what web site are you most likely to find a discussion of that new ALM model?The best place to get information about a new ALM model would be the/ site mentioned above. If a promising new model were developed it would be sure to show up in the discussion groups mentioned above.3. If you need guidance on how to prepare bank forecasts and measure risk as part of a bank’s ALM activities which web site could be most helpful to you?If you are not willing to go to a consultant about how to develop bank forecasts and measure risk, the / web site would probably be the most helpful site. There are many discussions there about how to deal with specific measurement issues and how to find information to determine the risk of your bank compared to peer institutions.85。

商业银行管理ROSE7e课后答案chapter_CHAPTER 10THE INVESTMENT FUNCTION IN BANKING AND FINANCIAL SERVICES MANAGEMENTGoal of This Chapter: The purpose of this chapter is to discover the types of securities that financial institutions acquire for their investment portfolio and to explore the factors that a manager should consider in determining what securities a financial institution should buy or sell.Key Topics in This ChapterNature and Functions of InvestmentsInvestment Securities Available: Advantages and DisadvantagesMeasuring Expected ReturnsTaxes, Credit, and Interest Rate RisksLiquidity, Prepayment, and Other RisksInvestment Maturity StrategiesMaturity Management T oolsChapter OutlineI.Introduction.Th.Role.Performe.b.Investmen.Securitie.i.Ban.P ortfoliosII.Investmen.Instrument.Availabl.t.Bank.an.Othe.Financia.Fir msIII.Popula.Money-Marke.InstrumentsA.Treasur.BillsB.Short-Ter.Treasur.Note.an.BondsC.Federa.Agenc.SecuritiesD.Certificate.o.DepositE.Internationa.Eurocurrenc.DepositsF.Bankers.Acceptancesmercia.PaperH.Short-Ter.Municipa.ObligationsIV.Popula.Capita.Marke.InstrumentsA.Treasur.Note.an.BondsB.Municipa.Note.an.BondsC.Corporat.Note.an.BondsIII.Othe.Investmen.Instrument.Develope.Mor.RecentlyA.Structure.NotesB.Securitize.AssetsC.Strippe.SecuritiesIV.Investmen.Securitie.Actuall.Hel.b.BanksV.Factor.Affectin.th.Choic.o.Investmen.SecuritiesA.Expecte.Rat.o.ReturnB.Ta.Exposureernmen.Bonds2.Ban.Qualifie.Bonds3.Ta.Swappin.Tool4.Th.Portfoli.Shiftin.ToolC.Interest-Rat.RiskD.Credi.o.Defaul.RiskE.Busines.RiskF.Liquidit.RiskG.Cal.RiskH.Prepaymen.RiskI.Inflatio.RiskJ.Pledgin.RequirementsVI.Investmen.Maturit.Strategiesdde.o.Spaced-Maturit.PolicyB.Th.Front-En.Loa.Maturit.PolicyC.Th.Back-En.Loa.Maturit.PolicyD.Th.Barbel.StrategyE.Th.Rat.Expectation.ApproachVII.Maturit.Managemen.ToolsA.Th.Yiel.CurveB.DurationVIII.Summar.o.th.ChapterConcept Checks10-1.Wh.d.bank.an.institution.choos.t.devot..significan.portio.o.thei. asset.t.investmen.securities?pl emen.t.th.advantage.loan.provide.Investment.generall.hav.les.cre di.ris.tha.loans.allo.th.ban.o.thrif.institutio.t.diversif.int.differen.lo calitie.tha.mos.o.it.loan.permit.provid.additiona.liqui.reserve.i.cas .an.regulatio.t.bac .governmen.deposits.hel.t.stabiliz.ban.incom.ove.th.busines.cycle .an.ai.bank.i.reducin.thei.exposur.t.taxes.10-2.Wha.ke.role.d.investment.pla.i.th.managemen.o..ban.o.othe.de positor.institution?See answer to 10-110-3.Wha.ar.th.principa.mone.marke.an.capita.marke.instrument.ava ilabl.t.institution.today.Wha.ar.thei.mos.importan.characteristics?Bank.purchas..wid.rang.o.investmen.securities.Th.principa.m one.marke.instrument.availabl.t.bank.toda.ar.Treasur.bills.federa. agenc.securities.CD'.issue.b.othe.depositor.institutions.Eurodolla. mercia.paper.an.short-mo.characteristic.o.mos.thes.instrument.i.thei.safet.an.hig.marketability.Capita.marke.instrument. ern men.note.an.bonds.mortgage-backe.securities.an.corporat.note.an.bonds.Th.characteristic.o.th es.securitie.i.thei.lon.ru.incom.potential.10-4.Wha.type.o.investmen.securitie.d.bank.prefe.th.most.Ca.yo.exp lai.why?Commercia.bank.clearl.prefe.thes.majo.type.o.investmen.sec urities.Unite.State.Treasur.securities.federa.agenc.securities.an.st ernmen.(municipal.bond.an.notes.The.hol.smal.am ount.o.equitie.an.othe.deb.securitie.(mainl.corporat.note.an.bon ds).The.pic.thes.type.becaus.the.ar.bes.suite.t.mee.th.objective.o.. bank.investmen.portfolio.suc.a.ta.sheltering.reducin.overal.ris.ex posure..sourc.o.liquidit.an.naturall.generatin.incom.a.wel.a.divers ifyin.thei.assets.10-5.Wha.ar.securitize.assets.Wh.hav.the.grow.s.rapidl.i.recen.years?Securitize.asset.ar.loan.tha.ar.place.i..poo.and.a.th.loan.gener at.interes.an.principa.income.tha.incom.i.passe.o.t.th.holder.o.sec uritie.representin.a.interes.i.th.loa.pool.Thes.loan-backe.securitie.ar.attractiv.t.man.bank.becaus.o.thei.highe.yield.a n.frequen.federa.guarantee.(i.th.case.fo.example.o.mos.home-mortgage-backe.securities.a.wel.a.thei.relativel.hig.liquidit.an.marketability 10-6.Wha.specia.risk.d.securitize.asset.presen.t.institution.investin.i.t hem?Securitize.asset.ofte.carr.substantia.interest-rat.ris.an.prepaymen.risk.whic.arise.whe.certai.loan.i.th.securitized-asse.poo.ar.pai.of.earl.b.th.borrower.(usuall.becaus.interes.rate.ha v.falle.an.ne.loan.ca.b.substitute.fo.th.ol.loan.a.cheape.loa.rates.o. ar.defaulted.Prepaymen.ris.ca.significantl.decreas.th.value.o.secu ritie.backe.b.loan.an.chang.thei.effectiv.maturities.10-7.Wha.ar.structure.note.an.strippe.securities.Wha.unusua.feature.d.the.contain?uall.ar.package.investment.assemble.b.secu rit.dealer.tha.offe.customer.flexibl.yield.i.orde.t.protec.thei.custo mers.investment.agains.losse.du.t.inflatio.an.changin.interes.rate ernmen.o.federa.agenc.sec urities.Strippe.securitie.consis.o.eithe.principa.payment.o.interes.pa yment.fro..deb.security.Th.expecte.cas.flo.fro..Treasur.bon.o.mort gage-backe.securit.i.separate.int..strea.o.principa.payment.an..strea.o.i nteres.payments.eac.o.whic.ma.b.sol.a..separat.securit.maturin.o. th.da.th.paymen.i.due.Som.o.thes.strippe.payment.ar.highl.sensit iv.t.change.i.interes.rates.10-8.Ho.i.th.expecte.yiel.o.mos.bond.determined?Fo.mos.bonds.thi.require.th.calculatio.o.th.yiel.t.maturit.(YT M.i.th.bon.i.t.b.hel.t.maturit.o.th.planne.holdin.perio.yiel.(HPY.bet wee.poin.o.purchas.an.poin.o.sale.YT.i.th.expecte.rat.o.retur.o..bo n.hel.unti.it.maturit.dat.i.reached.base.o.th.bond'.purchas.price.p romise.interes.payments.andredemptio.valu.a.maturity.HP.i..rat.o.discoun.bringin.th.curre n.pric.o..bon.i.lin.wit.it.strea.o.expecte.cas.inflow.an.it.expecte.sal. pric.a.th.en.o.th.bank'.holdin.period.10-ernmen.bon.i.expecte.t.matur.i.tw.year.an.ha..curren.pric.o .$950.wha.i.th.bond'.YT.i.i.ha..pa.valu.o.$1,00.an..promise.coupo.r at.o.1.percent.Suppos.thi.bon.i.sol.on.yea.afte.purchas.fo..pric.o.$ 970.Wha.woul.thi.investor'.holdin.perio.yiel.be?The relevant formula is:$950 = 221Y TM) 1(1000$Y TM) (1$100 Y TM) 1(100$+++++ Using a financial calculator we get:YTM = 12.99%If the bond is sold after one year, the formula entries change to:$950 = 11Y TM) (1$970 Y TM) 1(100$+++and the YTM is:YTM = 12.63%10-10.Wha.form.o.ris.affec.investments?Th.followin.form.o.ris.affec.investments.interest-rat.risk.credi.risk.busines.risk.liquidit.risk.prepaymen.risk.cal.risk. an.inflatio.risk.Interest-rat.ris.capture.th.sensitivit.o.th.valu.o.investment.t.interest-rat.movements.whil.credi.ris.reflectsth.ris.o.defaul.o.eithe.interes.o.principa.payments.Busines.ris. refer.t.th.impac.o.credi.condition.an.th.economy.whil.liquidit.ris.f ocuse.o.th.pric.stabilit.an.marketabilit.o.investments.Prepaymen. ris.i.specifi.t.certai.type.o.investment.an.focuse.o.th.fac.tha.som.l oan.whic.th.securitie.ar.base.o.ca.b.pai.of.early.Cal.ris.refer.t.th.ear l.retiremen.o.securitie.an.inflatio.ris.refer.t.thei.possibl.los.o.purch asin.power.。

ISO15765-3（20PP）道路车辆——控制局域网络诊断——第3部分：一元化诊断服务实施（CAN的UDS）道路车辆——控制器局域网（CAN）的诊断——第3部分：一元化诊断服务实施（CAN的UDS）1范围这部分ISO15765协议按照ISO14229-1，描述了在ISO11898定义的控制器局域网中统一诊断服务（UDS）的实施。

它给所有汽车连接至CAN网络服务器及外部测试设备提供诊断服务及服务器存储器编程的需求。

它对汽车内部CAN总线架构无任何要求。

2参考的标准下述的参考文档对于该文档的应用是必不可少的。

3术语，定义和缩略词为编撰该文档目的，这些术语和定义已在ISO14229-1，ISO15765-1及ISO15765-2中给出，以下缩略词术语同样适用。

DA目标地址ID标识符DLC数据长度码GW网关LSB最低有效位MSB最高有效位NA网络地址SA源地址SM子网掩码TOS服务类型4协定该部分ISO15765协议基于ISO14229-1的协定，该协议遵从使用到诊断服务的OSI服务协议。

5统一诊断服务（UDS）对照OSI模型的应用见图16应用层及会话层6.1应用层服务该部分ISO15765协议使用ISO14229-1的客户机-服务器式的应用层服务。

该系统具有测试、检测、监视，诊断及汽车服务器在线编程的功能。

6.2应用层协议该部分ISO15765协议使用ISO14229-1应用层协议。

6.3应用层诊断会话管理定时重要——任何一个服务器端产生的<N_Result>不等于N_OK的N_USData.indication的指示服务，服务器应用层都不应该有一个应答信息。

6.3.1概况下述的是应用层及会话层的定时参数及它们如何在客户机-服务器模式中如何处理的。

图1OSI模型中，基于CAN的UDS实施下述的几种通信会话方式需区别开：a)物理的通信在如下期间1）默认会话方式2）非默认的会话方式——需进行会话处理b)功能的通信在如下期间1）默认的会话方式2）非默认的会话方式——需进行会话处理所有的情况下，请求服务器否定应答信息的扩展的定时应答，包括应答码78heG应当予以考虑。

CHAPTER 8USING FINANCIAL FUTURES, OPTIONS, SWAPS, AND OTHER HEDGING TOOLSIN ASSET-LIABILITY MANAGEMENTGoal of This Chapter: The purpose of this chapter is to examine how financial futures, option, and swap contracts, as well as selected other asset-liability management techniques can be employed to help reduce a bank’s potential exposure to loss as market conditions change. We will also discover how swap contracts and other hedging tools can generate additional revenues for banks by providing risk-hedging services to their customers.Key Topics in this Chapter•The Use of Derivatives•Financial Futures Contracts: Purpose and Mechanics•Short and Long Hedges•Interest-Rate Options:Types of Contracts and Mechanics•Interest-Rate Swaps•Regulations and Accounting Rules•Caps, Floor, and CollarsChapter OutlineI. Introduction: Several of the Most Widely Used Tools to Manage Risk ExposureII. Use of Derivative ContractsIII. Financial Futures Contracts: Promises of Future Security Trades at a Set PriceA. Background on FuturesB. Purposes of Financial Futures TradingC. Most Popular Types of Futures ContractsD. The Short Hedge in FuturesE. The Long Hedge in Futures1. Using Long and Short Hedges to Protect Income and Value2. Basis Risk3. Basis Risk with a Short Hedge4 Basis Risk with a Long Hedge5. Number of Futures Contracts NeededIV. Interest Rate OptionsA. Nature of Interest-Rate OptionsB. How They Differ from Futures ContractsC. Most Popular Types of OptionsD. Purpose of Interest-Rate OptionsV. Regulations and Accounting Rules for Bank Futures and Options Trading105VI. Interest Rate SwapsA. Nature of swapsB. Quality swapsC. Advantages of Swaps Over Other Hedging MethodsD. Reverse swapsE. Potential Disadvantages of SwapsVII. Caps, Floors, and CollarsA. Interest Rate CapsB. Interest Rate FloorsC. Interest Rate CollarsVIII. Summary of the ChapterConcept Checks8-1. What are financial futures contracts? Which financial institutions use futures and other derivatives for risk management?Financial futures contacts are contracts calling for the delivery of specific types of securities at a set price on a specific future date. Financial futures contract help to hedge interest rate risk and are thus, used by any bank or financial institution that is subject to interest rate risk.8-2. How can financial futures help financial service firms deal with interest-rate risk?Financial futures allow banks and other financial institutions to deal with interest-rate risk by reducing risk exposure from unexpected price changes. The financial futures markets are designed to shift the risk of interest rate fluctuations from risk-averse investors to speculators willing to accept and possibly profit from such risks.8-3. What is a long hedge in financial futures? A short hedge?A long hedger offsets risk by buying financial futures contracts around the time new deposits are expected, when a loan is to be made, or when securities are added to the bank's portfolio. Later, as deposits and loans approach maturity or securities are sold, a like amount of futures contracts is sold. A short hedger offsets risk by selling futures contracts when the bank is expecting a large cash inflow in the near future. Later, as deposits come flowing in, a like amount of futures contracts is purchased.8-4. What futures transactions would most likely be used in a period of rising interest rates? Falling interest rates?Rising interest rates generally call for a short hedge, while falling interest rates usually call for some form of long hedge.8-5. How do you interpret the quotes for financial futures in The Wall Street Journal?106The first column gives you the opening price, the second and third the daily high and low price, respectively. The fourth column shows the settlement price followed by the change in the settlement price from the previous day. The next two columns show the historic high and low price and the last column points out the open interest in the contract.8-6. A futures is currently selling at an interest yield of 4 percent, while yields currently stand at 4.60 percent. What is the basis for these contracts?The basis for these contracts is currently 4.60% – 4% or 60 basis points.8-7. Suppose a bank wishes to sell $150 million in new deposits next month. Interest rates today on comparable deposits stand at 8 percent, but are expected to rise to 8.25 percent next month. Concerned about the possible rise in borrowing costs, management wishes to use a futures contract. What type of contract would you recommend? If the bank does not cover the interest rate risk involved, how much in lost potential profits could the bank experience?At an interest rate of 8 percent:= $1 million$150 million x 0.08 x 30360At an interest rate of 8.25 percent:$150 million x 0.0825 x 30= $1.031 million360The potential loss in profit without using futures is $0.0313 million or $31.3 thousand. In this case the bank should use a short hedge.8-8. What kind of futures hedge would be appropriate in each of the following situations?a. A financial firm fears that rising deposit interest rates will result in losses on fixed-rateloans?b. A financial firm holds a large block of floating-rate loans and market interest rates arefalling?c. A projected rise in market rates of interest threatens the value of the financial firm’sbond portfolio?a. The rising deposit interest rates could be offset with a short hedge in futures contracts (for example, using Eurodollar deposit futures).b. Falling interest yields on floating-rate loans could be at least partially offset by a long hedge in Treasury bonds.107c. The bank's bond portfolio could be protected through appropriate short hedges using Treasury bond and note futures contracts.8-9. Explain what is involved in a put option?A put option allows its holder to sell securities to the option writer at a specified price. The buyer of a put option expects market prices to decline in the future or market interest rates to increase. The writer of the contract expects market prices to stay the same or rise in the future.8-10. What is a call option?A call option permits the option holder to purchase specific securities at a guaranteed price from the writer of the option contract. The buyer of the call option expects market prices to rise in the future or expects interest rates to fall in the future. The writer of the contract expects market prices to stay the same or fall in the future.8-11. What is an option on a futures contract?An option on a futures contract does not differ from any other kind of option except that the underlying asset is not a security, but a futures contract.8-12. What information do T-bond and Eurodollar futures option quotes contain?The quotes contain information about the strike prices and the call and put prices at each different strike price for given months.8-13. Suppose market interest rates were expected to rise? What type of option would normally be used?If interest rates were expected to rise, a put option would normally be used. A put option allows the option holder to deliver securities to the option writer at a price which is now above market and make a profit.8-14. If market interest rates were expected to fall, what type of option would a financial institution’s manager be likely to employ?If interest rates were expected to fall, a call option would likely be employed. When interest rates fall, the market value of a security increases. The security can then be purchased at the option price and sold at a profit at the higher market price.8-15. What rules and regulations have recently been imposed on the use of futures, options, and other derivatives? What does the Financial Accounting Standards Board (FASB) require publicly traded firms to do in accounting for derivative transactions?108Each bank has to implement a proper risk management system comprised of (1) policies and procedures to control financial risk taking, (2) risk measurement and reporting systems and (3) independent oversight and control processes. In addition, FASB introduced statement 133 which requires that all derivatives are recorded on the balance sheet as assets or liabilities at their fair value. Furthermore, the change in the fair value of a derivative and a fair value hedge must be reflected on the income statement.8-16. What is the purpose of an interest rate swap?The purpose of an interest rate swap is to change an institution's exposure to interest rate fluctuations and achieve lower borrowing costs.8-17. What are the principal advantages and disadvantages of rate swaps?The principal advantage of an interest-rate swap is the reduction of interest-rate risk of both parties to the swap by allowing each party to better balance asset and liability maturities and cash-flow patterns. Another advantage of swaps is that they usually reduce interest costs for one or both parties to the swap. The principal disadvantage of swaps is they may carry substantial brokerage fees, credit risk and some basis risk.8-18. How can a financial institution get itself out of a swap agreement?The usual way to offset an existing swap is to undertake another swap agreement with opposite characteristics.8-19. How can financial-service providers make use of interest rate caps, floors, and collars to generate revenue and help manage interest rate risk?Banks and other financial institutions can generate revenue by charging up-front fees for interest rate caps on loans and interest rate floors on securities. In addition, a positive net premium on interest rate collars will add to a bank's fee income. Caps, floors, and collars help manage interest rate risk by setting maximum and minimum interest rates on loans and securities. They allow the lender and borrower to share interest rate risk.8-20. Suppose a bank enters into an agreement to make a $10 million, three-year floating-rate loan to one of its corporate customers at an initial rate of 8 percent. The bank and the customer agree to a cap and a floor arrangement in which the customer reimburses the bank if the floating loan rate drops below 6 percent and the bank reimburses the customers if the loan rate rises above 10 percent. Suppose that, at the beginning of the loan's second year, the floating loan rate drops to 4 percent for a year and then, at the beginning of the third year, the loan rate increases to 11 percent for the year. What rebates must be paid by each party to the agreement?The rebate owed by the bank for the third year must be:(11%-10%) x $10 million = $100,000.109The rebate that must be forwarded to the bank for the second year must be:(6%-4%) x $10 million = $200,000.Problems8-1. You hedged your bank’s exposure to declining interest rates by buying one March Treasury bond futures contract at the opening price on November 21, 2005(see exhibit 8-2). It is now January 9, and you discover that on Friday, January 6 March T-bond futures opened at 113-17 and settled at 113-16.a. What are the profits/losses on your long position as of settlement on January 6?Buy at 112-06 or 112 6/32 per contract = 112,187.50Value at settlement on January 6, 113-16 or 113 16/32 = 113,500.Gain = 113,500 – 112,187.50 = $1312.50b. If you deposited the required initial margin on 11/21 and have not touched theequity account since making that cash deposit, what is your equity accountbalance?The equity account balance will increase by the gain in the position,thus $1,150 + $1312.50 = $2,462.508-2 Use the quotes of Eurodollar futures contracts traded on the Chicago Mercantile Exchange on December 20, 2005 to answer the following questions:a. What is the annualized discount yield based on the low IMM index for the nearestJune contract?The annualized discount yield is 100 – 95.13 = 4.87 percentb. If your bank took a short position at the high price for the day for 15 contracts, whatwould be the dollar gain or loss at settlement on December 20, 2005?Sell at high price: (1,000,000x[1-((4.87/100)x90/360)]x15 = 14,817,375Value at settlement: (1,000,000x[1-((4.86/100)x90/360)]x15 = 14,817,750Loss: 14,817,375 – 14,817,750 = -$375c. If you deposited the initial required hedging margin in your equity account upontaking the position described in b, what would be the marked to market value ofyour equity account at settlement?Initial margin = $700x15 = $10,500110You realize a $375 loss for this transaction.Thus your equity position is: $10,500 - $375 = $10,1258-3. What kind of futures or options hedges would be called for in the following situations?a. Market interest rates are expected to increase and First National Bank’s asset andliability managers expect to liquidate a portion of their bond portfolio to meetdepositor’s demands for funds in the upcoming quarter.First National can expect a lower price when they sell their bond portfolio unless it uses short futures hedges in which contracts for government securities are first sold and then purchased at a profit as security prices fall provided interest rate really do rise as expected. A similar gain could be made using put options on government securities or on financial futures contracts.b. Silsbee Savings Bank has interest-sensitive assets of $79 million and interest-sensitive liabilities of $88 million over the next 30 days and market interest rates are expected to rise. Silsbee Savings Bank’s interest-sensitive liabilities exceed its interest-sensitive assets by $11 million which means the bank will be open to losses if interest rates rise. The bank could sell financial futures contracts or use a put option on government securities or financial futures contracts approximately equal in dollar volume to the $11 million interest-sensitive gap to hedge their risk.c. A survey of Tuskee Bank’s corporate loan customers this month (January) indicates that, on balance, this group of firms will need to draw $165 million from their credit lines in February and March, which is $65 million more than the bank’s management has forecasted and prepared for. The bank’s economist has predicted a significant increase in money market interest rates over the next 60 days.The forecast of higher interest rates means the bank must borrow at a higher interest cost which, other things held equal, will lower its net interest margin. To offset the expected higher borrowing costs the bank's management should consider a short sale of financial futures contracts or a put option approximately equal in volume to the additional loan demand. Either government securities or EuroCDs would be good instruments to consider using in the futures market or in the option market.d. Monarch National Bank has interest-sensitive assets greater than interest sensitive liabilities by $24 million. If interest rates fall (as suggested by data from the Federal Reserve Board) the bank’s net interest margin may be squeezed due to the decrease in loan and security revenue.Monarch National Bank has interest-sensitive assets greater than interest-sensitive liabilities by $24 million. If interest rates fall, the bank's net interest margin will likely be squeezed due to the faster fall in interest income. Purchases of financial futures contracts followed by a subsequent sale or call options would probably help here.111e. Caufield Thrift Association finds that its assets have an average duration of 1.5 years and its liabilities have an average duration of 1.1 years. The ratio of liabilities to assets is .90. Interest rates are expected to increase by 50 basis points during the next six months.Caufield Bank and Trust Company has asset duration of 1.5 years and a liabilities duration of 1.1.A 50-basis point rise in money-market rates would reduce asset values relative to liabilities which mean its net worth would decline. The bank should consider short sales of government futures contracts or put options on these securities or on their related futures contracts.8-4. Your bank needs to borrow $300 million by selling time deposits with 180-day maturities. If interest rates on comparable deposits are currently at 4 percent, what is the cost of issuing these deposits? Suppose deposit interest rates rise to 5 percent. What then will be the marginal cost of these deposits? What position and types of futures contract could be used to deal with this cost increase?At a rate of 4 percent the interest cost is:$300 million x 0.04 x 180= $6,000,000360At a rate of 5 percent the interest cost would be:= $7,500,000$300 million x 0.05 x 180360A short hedge could be used based upon Eurodollar time deposits.8-5. In response to the above scenario, management sells 300, 90-day Eurodollar time deposits futures contracts trading at an IMM Index of 98. Interest rates rise as anticipated and your bank offsets its position by buying 300 contracts at an IMM index of 96.98. What type of hedge is this? What before-tax profit or loss is realized from the futures position?Bank sells Eurodollar futures at (1,000,000*[1-((2/100)*90/360)] $995,000 (per contract)Bank buys Eurodollar futures at (1,000,000*[(1-(3.02/100)*90/360]$992,450 (per contract) Expected Before-tax Profit $ 2,550 (per contract)And Total Profit would be 300*$2550 = $765,000In this case the bank has employed a short hedge which partially offsets the higherborrowing costs outlined above.8-6. It is March and Cavalier Financial Services Corporation is concerned about what an increase in interest rates will do to the value of its bond portfolio. The portfolio currently has a market value of $101.1 million and Cavalier’s management intends to liquidate $1.1 million in bonds in June to fund additional corporate loans. If interest rates increase to 6 percent, the bond will sell for $1 million with a loss of $100,000. Cavalier’s management sells 10 June Treasury bond contracts at 109-05 in March. Interest rates do increase, and in June Cavalier’s ma nagement offsets its position by buying 10 June Treasury bond contracts at 100-03.112113a.What is the dollar gain/loss to Cavalier from the combined cash and futures market operations described above?Loss on cash transaction: $100,000Gain on futures transaction: 109,156.25 – 100,093.75 = 9062.5 (per contract)Loss: 9062.50(10) – 100,000 = -$9,375b. What is the basis at the initiation of the hedge?110,000 – 109,156.25 = 843.75c. What is the basis at the termination of the hedge?100,000 – 100,093.75 = -93.75d. Illustrate how the dollar return is related to the change in the basis from initiationfrom termination?Dollar return = -93.75 – 843.75 = -937.50 per contract or –937.50(10) = -$93758-7. By what amount will the market value of a Treasury bond futures contract change ifinterest rates rise from 5 to 6 percent? The underlying Treasury bond has a duration of 10.48 years and the Treasury bond futures contract is currently quoted at 113-06 (Remember that Treasury bonds are quoted in 32nds)Change in value = -10.48 x $113,187.50 x .01/(1+.05) = -$11,297.198-8. Trojan National Bank reports that its assets have a duration of 8 years and its liabilities average 3 years in duration. To hedge this duration gap, management plans to employ Treasury bond futures, which are currently quoted at 112-17 and have a duration of 10.36 years. Trojan ’s latest financial report shows total assets of $120 million and liabilities of $97 million.Approximately how many futures contracts will the bank need to cover its overall exposure?Number of Futures Contracts Needed = 25.531,112*36.10000,000,120*]3*120978[ = 5748-9 You hedged your bank’s exposure to declining interest rates by buying one March call on Treasury bond futures at the premium quoted on December 13th , 2005 (see exhibit 8-4).a. How much did you pay for the call in dollars if you chose the strike price of 110?(Remember that option premiums are quoted in 64ths.)Price per call = 2.625 x 100,000 = $262,500b. Using the following information for trades on December 21, 2005, if you sold thecall on 12/21/05 due to a change in circumstances would you have reaped a profitor loss? Determine the amount of the profit/loss.Sell call at: 3.125 x 100,000 = 312,500Gain = 312,500 – 262,500 = $50008-10 Refer to the information given for problem 9. You hedged your bank’s exposure to increasing interest rates by buying one March put on Treasury bond futures at the premium quoted on December 13th, 2005 (see exhibit 8-4).a. How much did you pay for the put in dollars if you chose the strike price of 110?(Remember that premiums are quoted in 64ths.)Price per put = .765625 x 100,000 = $76,562.25b. Using the above information for trades on December 21, 2005, if you sold the puton 12/21/05 due to a change in circumstances would you have reaped a profit orloss? Determine the amount of the profit/loss.Sell put at: .421875 x 100,000 = $42,187.50Loss = $42,187.50 – 76,562.25 = -$34,374.758-11. You hedged your thrift institution’s exposure to dec lining interest rates by buying one March call on Eurodollar deposits futures at the premium quoted on December 13th, 2005 (see exhibit 8-4).a. How much did you pay for the call in dollars if you chose the strike price of 9525?(remember that premiums are quoted in IMM index terms)Value of the call: 6.25 x $25 = $156.25b. If March arrives and Eurodollar Deposit Futures have a settlement index atexpiration of 96.00, what is your profit or loss? (Remember to include the premiumpaid for the call option).Payout from settlement: (9600-9525) 75 basis points x $25 = $1,875Net gain: $1,875 –$156.25 = $1,718.758-12. You hedged your bank’s exposure to increasing interest rates by buying one March put on Eurodollar deposit futures at the premium quoted on December 13th, 2005 (see exhibit 8-4).a. How much did you pay for the put in dollars if you chose the strike price of 9,550?(remember that premiums are quoted in IMM index terms)114Value of the put: 29.25 x $25 = $731.25b. If March arrives and Eurodollar Deposit Futures have a settlement index atexpiration of 96.00, what is your profit or loss? (Remember to include the premiumpaid for the put option).Payout from settlement: $0 (option is out of the money)Net loss: $0 - $731.25 = -$731.258-13. A bank is considering the use of options to deal with a serious funding cost problem. Deposit interest rates have been rising for six months, currently averaging 5 percent, and are expected to climb as high as 6.75% over the next 90 days. The bank plans to issue $60 million in new money market deposits in about 90 days. It can buy put or call options on 90 day Eurodollar time deposit futures contracts for a quoted premium of .31 or $775 for each million-dollar contract. The strike price is quoted as 9,500. We expect the futures to trade at an index of 93.50 within 90 days. What kind of option should the bank buy? What before tax profit could the bank earn for each option under the terms described?You are trying to protect the bank against rising interest rates, thus you want to buy a put option. Profit on put: payout from settlement = (9500-9350) 150 basis points x $25 = $3,750Net profit: $3,750 - $775 = $2,975If the bank bought the call option, the value at settlement would be $0 and the bank would loose the call premium of $775.8-14. Hokie Savings Bank wants to purchase a portfolio of home mortgage loans with an expected average return of 8.5 percent. The bank’s management is concerned that interest rates will drop and the cost of the portfolio will increase from the current price of $50 million. In six months when the funds become available to purchase the loan portfolio, market interest rates are expected to be in the 7.5 percent range. Treasury bond options are available today at a quoted price of $79,000 (per $100,000 contract), upon payment of a $700 premium, and are forecast to rise to a market value of $87,000 per contract. What before-tax profits could the bank earn per contract on this transaction? How many options should Hokie buy?Profit per contract: $87,000 - $79,000 -$700 = $7,300Hokie should buy enough options to offset the increase in the price of the loan portfolio. Thus, figure out the price increase and divide that number by 7,300 to get the number of options needed. 8-15. A savings and loan’s credit rating has just slipped, and half of its assets are long term mortgages. It offers to swap interest payments with a money-center bank in a $100 million deal. The bank can borrow short term at LIBOR (8.05 percent) and long term at 8.95 percent. The S&L must pay LIBOR plus 1.5 percent on short term debt and 10.75 percent on long term debt. Show how these parties could put together a swap deal that benefits both of them about equally.115This SWAP agreement would have the form:Fixed Rate the Floating Rate PotentialBorrower Pays the Borrower Interest-Rateif They Issue Pays on Short- SavingsLong-Term Bonds Term Loans of Each BorrowerS&L 10.75% LIBOR + 1.50% 1.20%Money- 8.95% LIBOR (8.05%) 0.90%Center BankDifference 1.80% 1.50% 0.30%in Rates Due toDifferences inCredit RatingsIf the money-center bank borrows long-term at 8.95 percent and the S&L at LIBOR + 1.50 percent (which is currently 8.05 + 1.50 or 9.55 percent) and they exchange interest payments, both would save if the S&L agreed to pay a portion of the bank’s basic borrowing rate. For example, the S&L could pay 160 basis points to the bank which would more than cover the difference. After the exchange in payments and basis points the S&L would pay 8.95% +1.6% or 10.55% which is lower than the S&L’s long term rate and the bank would pay 9.55%-1.6% or 7.95% which is less than the bank’s short term rate and each party would get the type of payment they want.8-16. A bank plans to borrow $55 million in the money market at a current interest rate of 4.5 percent. However, the borrowing rate will float with market conditions. To protect itself the bank has purchased an interest-rate cap of 5 percent to cover this borrowing. If money market interest rates on these funds suddenly climb to 5.5 percent as the borrowing begins, how much in total interest will the bank owe and how much of an interest rebate will it receive assuming the borrowing is only for one month?Total Amount Interest Number of Months Interest Owed = Borrowed * Rate Charged * 12= $55 million x 0..055 x 112= $0.527 million or $252,083.33.How much of an interest rebate will the bank receive for its one-month borrowing?116[]12MonthsofNumberxBorrowedAmt.xRateCap-RateInterestMarketRebateInterest == (.055 - .05) x $55 million x 112= $22,916.67.8-17. Suppose that Jasper Savings Association has recently granted a loan of $2.4 million to Fairhills Farms at prime plus .5 percent for six months. In return for granting Fairhills an interest cap of 8% on its loan, this thrift has received from this customer a floor rate on the loan of 6 percent. Suppose that, as the loan is about to start the prime rate declines to 5.25 percent and remains there for the duration of the loan. How much (in dollars) will Fairhill Farms have to pay in total interest on this six month loan? How much in interest rebates will Fairhills have to pay due to the fall in the prime rate?Total = Amount * Interest * Number of Months Interest Owed Borrowed Rate Charged 12= $2.4 million x (.0525 + .0050) x 612= $0.069 million or $69,000.Fairhills will have to pay an interest rebate to Exeter National Bank of:[]12MonthsofNumberxBorrowedAmt.xRateInterestCurrent-RebateFloorRebateInterest == (.060 - .0575) x $2.4 million x 612= $0.003 million or $3,000.117。

CHAPTER 2THE IMPACT OF GOVERNMENT POLICY AND REGULATION ON BANKING AND THE FINANCIAL SERVICES INDUSTRYGoal of This Chapter: This chapter is devoted to a study of the complex regulatory environment that governments around the world have created for banks and other financial service firms in an effort to safeguard the public’s savings, bring stability to the financial system, and prevent abuse of financial service customers.Key Topics Presented in This Chapter∙The Principal Reasons for Bank and Nonbank Financial-Services Regulation∙Major Bank and Nonbank Regulators and Laws∙The Riegle-Neal and Gramm-Leach-Bliley (GLB) Acts∙Key Regulatory Issues Left Unresolved∙The Central Banking System∙Organization and Structure of the Federal Reserve System and Leading Central Banks of Europe and Asia∙Industry Impact of Central Bank Policy ToolsChapter OutlineI. Introduction: Nature and Importance of Bank RegulationII. Banking RegulationA. Pros and Cons of Strict Rules1. To protect the public's savings2. To control the money supply3. To ensure adequate supply of loans and to ensure fairness4. To maintain confidence in the system5. To avoid monopoly powers6. To provide support for government activities7. To support special sectors of the economyB. The Impact of Regulation -The Arguments for Strict Rules versus Lenient Rules III. Major Banking Laws-Where and When the Rules OriginatedA. Meet the “Parents”: The Legislation That Created Today’s Bank Regulatorsa. National Currency and Bank Acts (1863-64)b. The Federal Reserve Act (1913)c. The Banking Act of 1933 (Glass-Steagall)d. Establishing the FDIC under Glass-Steagalle. Criticisms of the FDIC and Responses Via New Legislationf. Raising the FDIC Insurance LimitB. Instilling Social Graces and Morales-Social Responsibility LawsC. Legislation Aimed at Allowing Interstate Banking: Where Can the “Kids” Play?D. The Gramm-Leach-Bliley Act (1999): What Are Acceptable Activities forPlaytime?E. Telling the Truth and Not Stretching It-The Sarbanes-Oxley Accounting StandardsAct (2002)IV. The 21st Century Issues in an Array of New Laws, Regulations and Regulatory StrategiesA. The FACT ActB. Check 21C. New Bankruptcy RulesD. Federal Deposit Insurance ReformE. New Regulatory Strategies in a New Century and Unresolved Regulatory Issues V. The Regulation of Nonbank Financial-Service FirmsA.Regulating Thrift (Savings) Industry1.Credit Unions2.Savings and Loans and Savings Banks3.Money Market Funds4.Life and Property/Casualty Insurance Companies5.Finance Companies6.Mutual Funds7.Security Brokers and Dealers8.Financial ConglomeratesB.Are Regulations Really Necessary in the Financial Services Sector?VI. The Central Banking System: It’s Impact on Banks and the Decisions and Policies of Financial InstitutionsA. Organizational Structure of the Federal Reserve SystemB. The Central Bank's Principal Task -- Making and Implementing Monetary Policy1.The Open Market Policy Tool of Central Banking2.Other Central Bank Policy Tools3. A Final Note on Central Banking’s Impact of Financial FirmsVII. Summary of the ChapterConcept Checks2-1. What key areas or functions of a bank or other financial firm are regulated today? Among the most important areas of banking subject to regulation are the adequacy of a bank's capital, the quality of its loans and security investments, its liquidity position, fund-raising options, services offered, and its ability to expand through branching and the formation of holding companies.2-2. What are the reasons for regulating each of the key areas or functions named above? These areas are regulated, first of all (and primarily), to protect the safety of the depositors' funds so that the public has some assurance that its savings and transactions balances are secure. Thus, bank failure is viewed as something to be minimized. There is also a concern for maintaining competition and for insuring that the public has reasonable and fair access to banking services, especially credit and deposit services.Not all of the areas listed above probably should be regulated. Minimizing the risk of bank failure serves to shelter some poorly managed banks. The public would probably be better served in the long run by allowing inefficient banks to fail rather than propping them up. Moreover, regulation may serve to distort the allocation of resources in banking, such as by restricting price competitionthrough legal interest-rate ceilings and anti-branching laws which leads to overbuilding of physical facilities. The result is a waste of scarce resources.2-3. What is the principal role of the Comptroller of Currency?The Comptroller of the Currency charters and supervises the activities of national banks through its policy-setting and examinations.2-4. What is the principal job performed by the FDIC?The Federal Deposit Insurance Corporation (FDIC) insures the deposits of bank customers, up to a total of $100,000 per account owner, in banks that qualify for a certificate of federal insurance coverage. The FDIC is a primary federal regulator (examiner) of state-chartered, non-member banks. It is also responsible for liquidating the assets of banks declared insolvent by their federal or state chartering agency.2-5. What key roles does the Federal Reserve System perform in the banking and financial system?The Federal Reserve System supervises and examines the activities of state-chartered banks that choose to become members of its system and qualify for Federal Reserve membership and regulates the acquisitions and activities of bank holding companies. However, the Fed's principal responsibility is monetary policy -- the control of money and credit growth in order to achieve broad economic goals.2-6What is the Glass-Steagall Act and Why Was It Important in banking history?The Glass-Steagall Act, passed by the U.S. Congress in 1933, was one of the most comprehensive pieces of banking legislation in American history. It created the Federal Deposit Insurance Corporation to insure smaller-size bank deposits, imposed interest-rate ceilings on bank deposits, broadened the branching powers of national banks to include statewide branching if state banks possessed similar powers, and separated commercial banking from investment banking, thereby removing commercial banks from underwriting the issue and sale of corporate stocks and bonds in the public market.There are many people who feel that banks should have some limitations on their investment banking activities. These analysts focus on two main areas. First, they suggest that this service may cause problems for customers using other bank services. For example, a bank may require a customer getting a loan to purchase securities of a company it is underwriting. This potential conflict of interest concerns some analysts. The second concern deals with whether the bank can gain effective control over an industrial organization. This could make the bank subject to additional risks or may give unaffiliated industrial organizations a competitive disadvantage. Today, banks can underwrite securities as part of the Gramm-Leach Bliley Act (Financial Services Modernization Act). However, congress built in several protections to make sure that the bank does not take advantage of customers. In addition, banks are prevented from affiliating with industrial firms under this law.2-7. Why did the federal insurance system run into serious problems in the 1980s and 1990s? Can the current federal insurance system be improved? In what ways?The FDIC, which insures U.S. bank deposits up to $100,000, was not designed to deal with system-wide failures or massive numbers of failing banks. Yet, the 1980s ushered in more bank closings than in any period since the Great Depression of the 1930s, bringing the FDIC to the brink of bankruptcy. Also, the FDIC's policy of charging the same insurance fees to all banks regardless of their risk exposure encouraged more banks to gamble and accept substantial failure risk. The recent FDIC Improvement Act legislation has targeted this last area, with movement toward a risk-based insurance schedule and greater insistence on maintaining adequate long-term bank capital.2-8. How did the Equal Credit Opportunity Act and the Community Reinvestment Act address discrimination?The Equal Credit Opportunity Act stated that individuals could not be denied a loan because of their age, sex, race, national origin or religious affiliation or because they were recipients of public welfare. The Community Reinvestment Act prohibited banks from discriminating against customers based on the neighborhood in which they lived.2-9. How does the FDIC deal with most failures?Most bank failures are handled by getting another bank to take over the deposits and clean assets of the failed institution -- a process known as purchase and assumption. Those that are small or in such bad shape that no suitable bids are received from other banks are closed and the insured depositors are paid off -- a deposit payoff approach. Larger failures may sometimes be dealt with by open-bank assistance where the FDIC loans money to the troubled bank and may order a change in management as well. Large failing money-center banks may also be taken over and operated as "bridge banks" by the FDIC until disposed of.2-10. What changes have occurred in the U.S. banks’ authority to c ross state lines?In 1994 the Riegle-Neal Interstate Banking and Efficiency Act was passed. This law is complicated but allows bank holding companies with adequate capital to acquire banks or bank holding companies anywhere in U.S. territory. No bank holding company can control more than 10% of the deposits at the national level and more than 30% of the deposits at the state level. Bank holding companies are also not allowed to cross state lines solely for the purpose of collecting deposits. Banks must adequately support their local communities by providing loans there. Bank holding companies are also allowed to offer a number of interstate services without necessarily having branches in the state by allowing affiliated banks to act as agents for the bank holding in other states. This law also allows foreign banks to branch in the U.S. under the same rules as domestic banks.2-11. How have bank failures influenced recent legislation?Recent bank failures have caused huge losses to federal insurance reserves and damaged public confidence in the banking system. Recent legislation has tried to address these issues by providing regulators with new tools to deal with the failures, such as the bridge bank device, and by granting banks, through regulation, somewhat broader service powers and more avenues for geographic expansion through branch offices and holding companies in order to help reduce their risk exposure. In addition, the increase in bank failures has focused attention on the insurance premiums banks pay and through the FDIC Improvement Act allowed the FDIC to move towards risk based insurance premiums.2-12. What changes in banking regulation did the Gramm-Leach-Bliley (Financial Services Modernization) Act bring about? Why?The most important aspect of the law is to allow U.S. bank, insurance companies and securities companies to affiliate with each other either through a holding company structure or through a bank subsidiary. The purpose of this law is to allow these companies to diversify their service offerings and reduce their overall risk. In addition it is thought that this seems to offer customers the convenience of one stop shopping.2-13. What new regulatory issues remain to be resolved now that interstate banking is possible and security and insurance services are allowed to co-mingle with banking?There are several key issues that remain to be resolved. One issue is concerned with what we should do about the governmental safety net. We need to balance risk taking by financial firms with safety for depositors. Another aspect of this issue is how to protect taxpayers if financial firms are allowed to take on more risk. Another issue that needs to be resolved is what to do about financial conglomerates. We need to be sure that the financial conglomerate does not use the resources of the bank to prop another aspect of their business. In addition, regulators need to be better trained to adequately regulate the more complex organizations and functional regulation needs to be reviewed periodically to make sure it is working. A third area that needs to be resolved is whether banking and commerce should be mixed. Should a bank sell cars along with credit cards and other financial services?2-14 Why must we be concerned about privacy in the sharing and use of financial-service customer’s information? Can the financial system operate efficiently if the sharing of nonpublic financial information is forbidden? How far, in your opinion, should we go in regulating who gets access to private information?It is important to be concerned about how private information is shared because it is possible to misuse the information. For example, if an individual’s medical condition is known to the bank through its insurance division, the bank may deny a loan based on this confidential information.They can also share this information with outside parties unless the customer states in writing that this information cannot be shared. On the other hand, there could be much duplication of effort if no sharing information is allowed. This would lead to inefficiencies and higher costs to consumers. In addition, sharing of information would allow targeting of services to particular customer needs. At this point, no one is quite sure what information and how it will be shared. It appears that there will eventually be a compromise between customers’ needs for privacy and the financial-services company’s need for to share that information.2-15. Why were the Sarbanes-Oxley, Bank Secrecy and USA Patriot Acts enacted in the United States? What impact are these new laws and their supporting regulations likely to have on the financial-services sector?The Bank Secrecy Act requires any cash transaction of $10,000 or more be reported to the government and was passed to prevent money laundering by criminal organizations.The USA Patriot Act was enacted after the attacks of September 11 and is designed to find and prosecute terrorists. It was a series of amendments to the Bank Secrecy Act. It requires banks and financial service providers to establish the identity of any customer opening or changing accounts in the United States. Many banks are however concerned about the cost of compliance.The Sarbanes-Oxley Accounting Standards Act came as a response to the disclosure of manipulation of corporate financial reports and questionable dealings among leading commercial firms, banks and accounting firms. It prohibits false or misleading information about the financial performance of banks and other financial service providers and generally tries to enforce higher standards in the accounting profession.2-16 Explain how the FACT, Check 21, 2005 Bankruptcy and 2006 FDIC Insurance Reform acts are likely to affect the revenues and costs of financial firms and their service to customers. FACT requires the FTC to make it easier for individuals victimized by identity theft to file a theft report and requires credit bureaus to help victims resolve the problems. This should make it easier for customers to handle identity theft problems and may reduce costs to the financial institutions that serve these customers. Financial institutions should be able to spend less on reimbursing customers for theft problems and perhaps the instances of identity theft will also be reduced at the same time.Check 21 allows financial institutions to send substitute checks to other banks to clear checks rather than the checks themselves. The substitute checks can be electronic images that can be transferred in an instant at a much lower cost to other institutions. This should reduce costs to institutions as they do not have to have an employee physically transfer checks anymore. In addition, financial institutions should know more quickly whether a check is good and this should reduce fraud and other costs associated with bad checks.2005 Bankruptcy Law requires that all higher income borrowers to pay back at least a portion of the money they have borrowed to the bank. Higher income borrowers will be required to make payment plans rather than have all of their debts forgiven. This should lower bad debt costs to financial institutions and may lower borrowing costs for all borrowers.Federal Deposit Insurance Reform raises the deposit insurance limits for certain retirement accounts and allows regulators to periodically adjust deposit insurance limits for inflation. This should allow investors to put more money into insured deposit accounts and may allow banks to have a more stable and reliable source of funds for loans and other investments. This will probably have the effect of increasing bank revenues and/or reducing expenses for the bank.For all of these new laws, the effect should be to make the bank more profitable because of higher revenues or lower expenses. At the same time these new laws allow financial institutions to better serve their customers.2-17.In what ways is the regulation of nonbank financial institutions different from the regulation of banks in the United States? How are they similar?Most nonbank financial institutions are considered “vested with the public interest” and therefore, face as close supervision from federal and state supervisors as banks do. However, some institutions are solely regulated at the federal level while others are only regulated at the state level.2-18. Which financial service firms are regulated primarily at the federal level and which at theSome regulators and experts are concerned because they feel that state regulators might not have the expertise to deal with the new more complex financial firm that exists today. They are also concerned because the new ‘functional’ regulation is not neces sarily coordinated between different regulatory agencies. Only time will tell if this functional regulatory structure is effective. 2-19. Can you make a case for having only one regulatory agency for financial service firms? Yes a case can easily be made for financial service firms. Problems in one area such as security brokerage services or insurance may eventually lead to problems in the traditional banking area or visa versa. One regulatory agency might be more likely to find these overlapping problems and prevent them before they cause the collapse of the entire organization. In addition, one regulatory agency may be able to better identify and prevent the inherent conflicts of interest that exist when a large financial conglomerate is formed.2-20. What is monetary policy?Monetary policy consists of regulation and control over the growth of money and credit in an attempt to pursue broad economic goals such as full employment, avoidance of inflation, and sustainable economic growth. Its principal tools are open market operations, changes in the discount (lending) rate, and changes in reserve requirements behind deposits.2-21. What services does the Federal Reserve System provide to depository institutions? Many services needed by banks are provided by the Federal Reserve Banks. Among the most important services provided by the Fed are checking clearing, the wiring of funds, shipments of currency and coin, loans from the Reserve banks to qualified depository institutions, and the supplying of information concerning economic and financial trends and issues. The Fed began charging for its services in order to help recover the added costs of deregulation which made more institutions eligible for Federal Reserve services and also to encourage the private marketplace to develop and offer similar services (such as check clearing and wire transfers).2-22. How does the Federal Reserve affect the banking and financial system through open market operations (OMO)? Why is OMO the preferred tool for many central banks around the globe?Open market operations consist of the buying and selling of securities by the central bank in an effort to influence and shape the course of interest rates and the growth of money and credit. Open-market operations, therefore, affect bank deposits -- their volume and growth -- as well as the volume of lending and the interest rates attached to bank borrowings and loans as well as the value of bank stock. OMO is the preferred tool, because it is also the Central Bank’s most flexible tool. It can be used every day and any mistakes can be quickly reversed.2-23 What is a primary dealer and why are they important?A primary dealer is a dealer in U.S. Treasury Bills and other securities that meets the Federal Reserve System requirements for trading directly with the Fed’s trading desk inside the New York Federal Reserve. It is through these trades with primary dealers that the Federal Reserve carries out its monetary policy objectives and influences the economy including the supply of money and credit and interest rates. Primary dealers have an integral role to play in the economy of the U.S. 2-24. How can changes in the central bank loan discount rate and reserve requirements affect the operations of depository institutions? What happens to the legal reserves of the banking system when the Fed grants loans through the discount window? How about when these loans are repaid? What are the effects of an increase in reserve requirements?The Discount Window is the department in each Federal Reserve Bank that receives requests to borrow reserves from banks and other depository institutions which are eligible to obtain credit from the Fed for short periods of time. The rate charged on such loans is called the discount rate. Reserve requirements are the amount of vault cash and deposits at the Federal Reserve banks that depository institutions raising funds from sources of reservable liabilities (such as checking accounts, business CDs, and borrowings of Eurodollars from abroad) must hold. If the Fed loans $200 million in reserves from the discount window, total reserves will rise by the amount of the discount window loan, but then will fall when the loan is repaid. Increasing reserve requirement means that depository institutions must keep more vault cash and reserves with the Federal Reserve for each deposit account they hold. This would have the effect of making less money available for loans. Since this has a multiplicative effect on the economy it can have a severe effect on the total amount of loans made and on the growth of the money supply that results.2-25. How did the Federal Reserve change the policy and practice of the discount window recently? Why was this change made?The Fed created two new loan types, primary and secondary credit, which replaced the existing adjustment and extended credit. Primary credit is extended to sound borrowing institutions at a rate slightly higher than the federal funds rate. Secondary credit is extended to institutions that do not qualify for primary credit for temporary funding needs at a rate slightly above the prime rate. These changes were implemented to encourage greater use of the discount window and to bring greater stability the federal funds rate and to the money market as a whole.2-26. How does the structure of the European Central Bank (ECB) appear to be similar to the structure of the Federal Reserve System? How are these two powerful and influential central banks different from one another?Like the Fed the ECB consists of a governing board and a policy making council and just like the Fed’s board of governors works with the 12 regional Federal Reserve banks the ECB has a cooperative arrangement with each EU member nation’s central bank. The policy menu of the ECB however is a lot simpler than its counterpart at the Fed. The central goal is price stability, which is largely achieved through open market operations and reserve requirements.Problems2-1. For each of the actions described explain which government agency or agencies a financialmanager must deal with and what banking laws are involved:A. Chartering a new bank.B. Establishing new bank branch offices.C. Forming a bank or financial holding company.D. Completing a bank merger.E. Making holding company acquisitions of nonbank businesses.A. For chartering a new bank in the United States either the state banking commission of thestate where the bank is to be headquartered must be consulted or the Comptroller of theCurrency must be sent an application for a national charter. The National Banking Actgoverns national charters while state charters are governed by rules laid down in statebanking statutes.B. Requests for new branch offices must also be made of the bank's chartering agency -- eitherthe state banking commission for state-chartered banks or the Comptroller of the Currencyfor national banks in the United States.C. Requests for holding company formation must be submitted to the Federal Reserve Boardor, for certain routine transactions, to the Federal Reserve Bank in the district. Some statesrequire their banking commissions to be notified if a holding company acquires a bankwithin the state's borders.D. The Bank Merger Act requires the approval of a bank's principal federal supervisoryagency for a proposed merger even if the bank is state chartered. Mergers involvingnational banks must be approved by the Comptroller of the Currency and by the statebanking commission if a bank has a state charter of incorporation. The merger must also bereviewed by other federal agencies that have supervisory responsibility for a bank, such asthe FDIC or the Federal Reserve, and by the U.S. Department of Justice.E. Request for acquisitions of nonbank businesses must be approved by the Federal ReserveBoard. For some more routine transactions, the Federal Reserve Bank in the distract canmake the decision.2-2. See if you can develop a good case for and against the regulation of financial institutions inthe following areas:A. Restrictions on the number of new financial-service institutions allowed to enterthe industry each year.B. Restrictions on which depository institutions are eligible forgovernment-sponsored deposit insurance.C. Restrictions on the ability of financial firms to underwrite debt and equitysecurities issued by their business customers.D. Restrictions on the geographic expansion of banks and other financial firms such aslimits on branching and holding company acquisitions across county, state, andinternational borders.E. Regulations on the bank failure process, defining when banks and other financialfirms are to be allowed to fail and how their assets are to be liquidated.A. Restricting entry into the banking industry limits competition and, to some extent, protectssome banks from failure, reducing the risk of depositor loss. On the other hand, limiting new firms props up some financial-service firms that should be allowed to fail if the system is to be as efficient as it can be.B. Restrictions on which banks can get deposit insurance also limits competition butencourages some banks to take on more risk because most depositors are protected by the insurance. Restricting which institutions are eligible for deposit insurance may limit the losses to the federal agency providing that insurance but may also limit that federalagency’s ability to monitor and control the money supply and the economy as a result. C. Limits on underwriting securities reduce a bank's revenue potential and will probablyresult in losing some of the largest corporate customers to foreign banks who face morelenient regulations. On the hand, underwriting securities is inherently risky and limiting this may limit the risk of the bank. It may also prevent the conflicts of interest that arise when a bank makes loans and underwrites securities at the same time.D. Limiting a bank's ability to expand geographically exposes it to greater risk of economicfluctuations within its local market area and makes it more prone to failure. On the other hand, allowing a bank to expand geographically may concentrate power in the hands of a few large institutions that make it more likely that service costs will rise for all customers.E. Protecting banks from failure inevitably involves sheltering some inefficient and poorlymanaged institutions that waste resources and fail to serve customers effectively. It alsotends to make the average customer less vigilant about the quality and risk of a particular bank's services and operations because deposits are insured and bank failure seems to most customers to be a relatively remote possibility. On the other hand, it makes customersmore confident in the system as a whole and makes a bank run less likely.2-3. Consider the issue of whether or not the government should provide a system of deposit insurance. Should it be wholly or partly subsidized by the taxpayers? What portion of the cost should be borne by depository institutions? by the depositors? Should riskier depository institutions pay higher deposit insurance premiums? Explain how you would determine exactly how big an insurance premium each bank should pay each year.。

CHAPTER 4CREATING AND MANAGING SERVICE OUTLETS:NEW CHARTERS, BRANCHES, AND ELECTRONIC FACILITIESGoal of This Chapter: The purpose of this chapter is to learn how new banks are chartered by state and federal authorities in the United States, to determine what makes a good site for a new branch office, to recognize how the role of branch offices is changing, and to explore the advantages and disadvantages of automated banking facilities.Key Topics in This Chapter•Chartering New Financial Service Institutions•Performance of New Banks•Establishing Full Service Branches•In-Store Branching•Establishing Limited Service Facilities•ATMs and Telephone Centers•The Internet and Online BankingChapter OutlineI. IntroductionA. The Importance of Convenience and Timely Access to CustomersB. Service Options Available Today1. Chartering New (De Novo) Financial Institutions2. Establishing New Full-Service Branches3. Setting Up Limited-Service FacilitiesII.Chartering a New Bank or Other Financial Service InstitutionsIII.The Bank Chartering Process in the United StatesA. The Chartering Authorities in the U.S.B. Benefits of Applying for a National CharterC. Benefits of Applying for a State CharterIV. Questions Regulators Usually Ask the Organizers of a New BankV. Factors Weighing on the Decision to Seek a New Bank CharterA. External Factors1. Level of Economic Activity2. Growth of Local Economic Activity3. The Need for a New Bank4. Strength and Character of Local Competition in Supplying FinancialServicesB. Internal Factors1. Qualifications and Contacts of the Organizers2. Management Quality3. Pledging of Capital and Funds to Cover the Cost of Filing a CharterApplication and Getting UnderwayVI. Volume and Characteristics of New Bank ChartersA. Numbers of New ChartersB. Characteristics of New Charter MarketsVII. How Well Do New Banks Perform?A. New Bank Financial PerformanceB. Pro-Competitive Effects on Service Offerings and Service PricingVIII. Establishing Full-Service Branch Offices: Choosing Locations and Designing New BranchesA. Advantages of Full-Service BranchesB. Trends in the Design of New BranchesC. Desirable Sites for New BranchesD. Expected Rate of ReturnE. Geographic DiversificationF. Branch RegulationG. The Changing Role of BranchesH. In-Store BranchingIX. Establishing and Monitoring Automated Limited-Service FacilitiesX. Point-of-Sale TerminalsXI. Automated Tellers (ATMs)A. History of ATMsB. ATM ServicesC. Fee Structures for ATM UsageD. Customer Service Limitations of ATMsE. Example of the ATM Capital-Budgeting DecisionXII. Home and Office Online BankingA. Telephone Banking and Call CentersB. Internet Banking1. Services Provided Through the Internet2. Challenges in Providing Internet Services3. The Net and Customer Privacy and SecurityXIII. Financial Service Facilities of the FutureXIV. Summary of the ChapterConcept Checks4-1. Why is the physical presence of a bank still important to many bank customers despite recent advances in long-distance communications technology?Many customers still prefer the personal attention and personal service that contact with bank employees provides. Moreover, for those services where problems can arise that require detailed information and explanation-for example, when a checking account is overdrawn and checks begin to bounce-the customer needs quick access and, often, the personal attention to his or her problem on the part of one or more employees.4-2. Why is the creation (chartering) of new banks closely regulated? What about nonblank financial firms?The creation of new banks is regulated to insure the safety and soundness of existing banks and to avoid excessive numbers of bank failures. The same arguments are usually made for non-bank financial firms. Financial-Service firms hold the public’s savings, are the heart of the payment system and create money. The failure of these firms could disrupt the economy and too many could mean in excessive growth in the money supply and inflation.4-3. What do you see as the principal benefits and costs of government regulation of the number of financial service charters issued?While control over the entry of new banks may reduce the number of failures, it also limits competition, so that the public may receive a smaller volume or lower quality of services at excessive prices.4-4. Who charters new banks in the United States? New thrift institutions?New banks are chartered by the banking commissions of the individual states or, at the federal level, by the Comptroller of the Currency. Thrift institutions are chartered by the states or at the federal level by the Office of Thrift Supervision.4-5. What key role does the FDIC play in the chartering process?The FDIC exercises some control over state bank charter activity as well as federal charters because most states insist that their new banks qualify for federal deposit insurance before they can open for business.4-6. What are the advantages of having a national bank charter? A state bank charter?The benefits of a national charter are:a.)It brings prestige due to stricter regulations and may help attract more customersb.)In times of trouble the technical assistance given may be better ensuring a betterchance of long run survivalThe benefits of a state charter are:a.)It may be easier and less costly to get a state charterb.)The bank does not have to join the Federal Reserve and therefore avoids buying andholding low yield stock of the Federal Reservec.)Many states let a bank lend more to one borrowerd.)State chartered banks may be able to make types of loans that a nationally charteredbank cannot4-7. What kinds of information must the organizers of new national banks provide the Comptroller of the Currency in order to get a charter? Why might this required information be important?The Comptroller of the Currency asks for information on the number of competing banks and bank-like institutions in the service area of the proposed bank. More competitive market situations limit the profit potential and perhaps the growth potential of a new bank. Also requested is information about shopping centers, retail and wholesale business activity, recent population growth, traffic counts, and personal income levels - all viewed as indicators of potential demand for banking services in the service area of the proposed new bank. Applicants must also provide background information on the organizers and proposed management of a new bank so the Comptroller can decide if these people are qualified, law-abiding, and trustworthy to manage the public's funds as well as their own.4-8. Why do you think the organizers of a new financial firm are usually expected to put together and submit to the chartering authority a detailed business plan, including marketing, management, and financial components?This demonstrates to regulators that the organizers of the bank have the expertise, experience and skills necessary to be successful in managing the new bank. If the organizers of a bank do not know where they are going, they are unlikely to be successful. In addition, it demonstrates whether the organizers of the new bank have a realistic picture of the community they are planning on serving and whether the organizers have a realistic view of the profit potential in the new bank. 4-9. What are the key factors the organizers of a new financial firm should consider before deciding to seek a charter?While a variety of factors are examined by different business people interested in establishing a new bank, most look at some or all of the following factors.1. External Factorsa. The level of local economic activity.b. Growth of local economic activity.c. The need for a new bank.d. The strength and character of local competition in supplying financialservices.2. Internal Factorsa. Qualifications and contacts of the new bank's organizers.b. Management quality.c. Pledging of capital and funds to cover the cost of filing a charter applicationand begin operations.4-10. Where are most new banks chartered in the United States?New charters tend to be concentrated in large urban areas where expected rates of return on the organizers investments are likely to be the highest. As the population increases relative to the number of financial firms, the number of new charters increases. The success of local banksalready in the area suggests that new financial firms would also be successful. Places where the concentration ratio for new banks has increased tend to have fewer new bank charters.4-11. How well do most new banks perform for the public and for their owners?Most new banks succeed, especially those whose organizers can bring in new deposits and loan accounts during the first year of the bank's operation. Most are profitable within two to three years of opening. There is some ev idence that newly charted banks are financially ‘fragile’ and more prone to failure than existing banks. They appear to be more vulnerable to real estate crises than established banks. New banks tend to under perform their competitors until they have been around for a while and new banks are more closely supervised than established banks.4-12. Why is the establishment of new branch offices usually favored over the chartering of new financial firms as a vehicle for delivering financial services?The chartering of a new financing corporation is normally a lengthy and expensive process, requiring the completion of elaborate federal or state application forms, while the branch application process is normally far simpler and less costly. Moreover, with the increase in the number of failures in recent years regulatory-imposed capital requirements for new charters have increased substantially, while new branch offices usually carry significantly lower capital requirements. Moreover, branch offices themselves are often much less elaborate and costly to build and maintain than are the headquarters' facility of a new institution where some duplicate facilities can be eliminated (for example, checking processing, credit analysis, and records departments).4-13. What factors are often considered in evaluating possible sites for new branch offices? Bankers first need to decide the goals and objectives of a new facility. Often this means assessing whether the proposed new branch is aimed at selling one or more particular services, such as deposits or loans, and also deciding how closely correlated cash flows and returns from the new branch office may be with cash flows and returns from the other facilities operated by the bank. If returns or cash flows through the proposed new institution are negatively correlated or display low positive correlation with the institution's other facilities, they may be able to lower the variance of its returns or cash flows by proceeding to establish the new office.Other considerations revolve around the economic strength of the proposed branch officesite-whether there is adequate traffic volume, large numbers of stores and shops, older or younger age populations who often require slightly different menus of services, recent area population growth, density and income, the occupational and residential makeup of the proposed new branch area, a large enough population to generate enough customers to breakeven and the number and size of facilities operated by competitors. Generally, for branches designed to attract and hold deposits key factors to consider usually revolve around individual and family incomes, concentrations of retail stores and shops, older-than-average residents, and homeowners rather than renters. For branch facilities emphasizing credit services residential areas with substantial new construction activity, heavy traffic flow, and high concentrations of stores and shopping centers are typically desirable for consumer and retail loan demand, while central city office locations are often chosen as locations for commercial loan facilities.4-14. What changes are occurring in the design of, and the roles played by, branch offices? Please explain why these changes are occurring.Bank branches are increasingly becoming selling platforms in which more and more fee-based services are attractively and prominently advertised in order to maximize the fee-income generating potential of each branch. Moreover, branches are becoming increasingly automated to reduce personnel and other operating costs and improve speed, efficiency, and accuracy in handling a growing service volume. Branch design has come to reflect these trends with automated facilities placed at easy access points, along with information booths to speedily direct customers to the service areas they need. Human tellers may be placed deeper inside branch facilities so that customers must pass by other service departments and conspicuous advertising in order to encourage customers to become aware of and avail themselves of other bank services.4-15. What laws and regulations affect the creation of new bank and thrift branches and the closing of existing branches? What advantages and what problems can the closing of a branch office create?The opening of new branch off ices must be approved by a bank's or thrift’s principal federal or state supervisor. Closing a branch office has become much more complicated in recent years as the result of several new laws and regulations. For example, the FDIC Improvement Act requires 90 days advance notice of branch closings to both customers and the principal supervisory agency and a posting on the branch site at least 30 days prior to closing. Banks and thrifts must also make an "affirmative effort" to reach all segments of their communities without discrimination under the terms of the Community Reinvestment Act which raises the danger of customer protests against closings if it appears the bank is under-serving certain groups of customers. Finally, the Community Reinvestment Act can be used as a vehicle to prevent U.S. banks and thrifts from branching expansion when they have a poor record of serving all segments of their communities. Closing selected branch offices can reduce operating costs and divert resources from less profitable to more profitable uses. However, they risk alienating good customer relationships unless it can serve those same customers with its remaining facilities.4-16. What new and innovative sites have been selected for new branch offices in recent years? Why have these sites been chosen by financial firms? Do you have any ideas about other sites that you believe should be considered?Rapid increases in new branches located in grocery stores, shopping centers, and inside other businesses and facilities where the public frequently gathers have helped to reduce branch construction costs and promote cross-selling of goods and financial services. Other branches have been opened in apartment complexes, senior citizen centers, and other customer-convenient locations as bankers come to realize they must adjust their service locations and service hours to conform to customer needs in an intensely competitive financial-services environment.4-17. What are POS terminals and where are they usually located?Point-of-sale terminals are set up to accommodate customer purchases of goods and services. These computer terminals normally are located in retail stores, gasoline stations, and similar places with a link to the banks’ own computer records. When a customer of the bank makes a purchase, the amount of the transaction is deducted from the customer's deposit account and added to the store's account. Because the customer immediately loses funds many bank customers have been hesitant to use the service as opposed to paying by check or credit card where payment is delayed for a few days. However, this depends on whether the POS terminal is an offline or online terminal. An offline terminal accumulates all transactions until the end of the day when all transactions are su btracted from a customer’s account. This type of terminal is less costly for the bank to operate. An online terminal subtracts the transactions immediately from the customer’s account and reduces the chance of an overdraft occurring but is more expensive for the bank to operate. Consumer reluctance to use POS terminals appears to be fading and as fees for other services rise this reluctance will continue to disappear.4-18. What services do ATMs provide? What are the principal limitations of ATMs as a service provider? Should ATM carry fees? Why?The earliest ATMs provided a convenient mechanism for cashing checks, making deposits, and verifying checking account balances, often at hours when the full-service branch offices were closed. Today, ATMs frequently provide a wide menu of old and new services, including bill paying, transfer of funds between accounts, and the purchase of tickets for travel and entertainment. Most authorities expect ATM usage to grow rapidly as these machines offer more services and as bankers increasingly move to restrict customer access to more costly human tellers and other bank personnel, often by charging extra fees for personal service.ATMs do have some significant limitations that bankers will have to work to overcome. They break down and need to be replaced, sometimes quite frequently and annoyingly for customers, and as technology changes often become quickly outdated. Customer activity around ATMs, particularly at night, has invited criminals to steal money and injure customers, sometimes creating liability for banks. Moreover, not all customers make use of these facilities due to a preference for personalized service, fear of crime, or unfamiliarity with how the machines work. Customer education and better service pricing are two important tools that could help with these problem areas in the future. In addition, ATMs do not rank high in their ability to sell peripheral services. Some banks have found that there has been a sharp decline in their ability to sell other services. Finally, ATMs are not necessarily profitable for all banks. Because they are available 24 hours, some customers may make more frequent and smaller withdrawals from the machine than they would with a human teller, driving up the costs. In addition, these same customers will often still demand a human teller to deposit their pay check, making the bank keep both tellers and ATM machines.Whether ATM should carry a fee is rather controversial. Recently, two of the largest ATM networks have decided to let owners of ATMs charge non-customers a surcharge. Several regional have begun to charge fees as well. These fees reflect the usage of ATMs. About 85% of all ATM transactions consist of cash withdrawals and only about 10 percent represent incoming deposits. In addition, in many places, ATM usage has declined as customers pass over ATMs in favor of credit and debit cards, onsite terminals and the internet.4-19. What are self-service terminals and what advantages do they have for financial institutions and their customers?Self-service terminals include ATMs and other computer-based limited-service facilities that permit a customer to call up information about his or her account and recent transactions with the institution or information about different services that the customer might be interested in purchasing. Many are accessible 24 hours a day or are easier to get to rather than wait for the help of personnel. They can save on resources by saving on staff time. Many institutions are adding telephones and video screens so that customers with problems can dial up an employee day or night with problems. This is also saving money because they can avoid duplication of staff at each branch.4-20. What financial services are currently available from banks on the internet? What problems have been encountered in trying to offer internet services?Customers can make payments, check on account balances, move funds between accounts and get applications for loans, deposits and other services. In addition banks can advertise on the web. Some of the problems include protecting customers’ privacy and heading off crime. In addition, the web does not make it easy for a bank to get to know their customers personally. The cost may also be prohibitive to some customers.4-21. How can financial firms better promote internet services?They need to emphasize the safety of their internet services. They need to promote their home page at every opportunity and update it frequently to keep customers’ interest. They need to survey customers about their satisfaction with the services and encourage dialogue via e-mail to resolve problems. They can also provide programs to download to act as screen savers (and advertisements) and also information about the institution and the services it provides. Problems4-1. A group of businessmen and women from the town of Mathews are considering filing an application with the state banking commission to charter a new bank. Due to a lack of current banking facilities within a 10-mile radius of the community, the organizing group estimates that the initial banking facility would cost about $3.2 million to build along with another $700,000 in other organizing expenses and would last for about 20 years. Total revenues are projected to be $510,000 the first year, while total operating expenses are projected to reach $180,000 in year 1. Revenues are expected to increase 6 percent annually after the first year, while expenses will grow an estimated 5 percent annually after year 1. If the organizers require a minimum of a 10 percent annual rate of return on their investment of capital in the proposed new bank, are they likely to proceed with their charter application given the above estimates?Year Revenues Op Expense Net Profits1 $510,000 $180,000 $330,0002 $540,600 $189,000 $351,6003 $573,036 $198,450 $374,5864 $607,418 $208,373 $399,0465 $643,863 $218,791 $425,0726 $682,495 $229,731 $452,7647 $723,445 $241,217 $482,2288 $766,851 $253,278 $513,5739 $812,863 $265,942 $546,92110 $861,634 $279,239 $582,39511 $913,332 $293,201 $620,13112 $968,132 $307,861 $660,27113 $1,026,220 $323,254 $702,96614 $1,087,793 $339,417 $748,37715 $1,153,061 $356,388 $796,67316 $1,222,245 $374,207 $848,03817 $1,295,579 $392,917 $902,66218 $1,373,314 $412,563 $960,75119 $1,455,713 $433,191 $1,022,52220 $1,543,056 $454,851 $1,088,205Initial Investment $3,900,000Required Rate of Return 0.10Present Value of Future CashFlows $4,491,642Net Present Value of Investment $591,642Given the above information, the organizers are likely to proceed given that the net present value of this investment is positive. The return they are going to earn is greater than the 10% they need to earn.4-2. Andover Savings Bank is considering the establishment of a new branch office at the corner of Lafayette and Connecticut Avenues. The savings association’s Economics Department projects annual operating revenues of $1.75 million from services sold to generate fee income and annual branching operating expenses of $880,000. The cost of procuring the property is $2.5 million and branch construction will total an estimated $2.32 million; the facility is expected to last 16 years. If the savings bank has a minimum acceptable rate of return on its invested capital of 12 percent, will Andover likely proceed with this branch office project?Year Revenues Op Expenses Net Profits1 $1,750,000 $880,000 $870,0002 $1,750,000 $880,000 $870,0003 $1,750,000 $880,000 $870,0004 $1,750,000 $880,000 $870,0005 $1,750,000 $880,000 $870,0006 $1,750,000 $880,000 $870,0007 $1,750,000 $880,000 $870,0008 $1,750,000 $880,000 $870,0009 $1,750,000 $880,000 $870,00010 $1,750,000 $880,000 $870,00011 $1,750,000 $880,000 $870,00012 $1,750,000 $880,000 $870,00013 $1,750,000 $880,000 $870,00014 $1,750,000 $880,000 $870,00015 $1,750,000 $880,000 $870,00016 $1,750,000 $880,000 $870,000Initial Investment $4,820,000Required Rate of Return 0.12Present Value of Future CashFlows $6,067,368Net Present Value of Investment $1,247,368Andover is likely to proceed with this project because the net present value is positive. This means that the interest rate that Andover will earn on this project is higher than the 12% they need to earn. 4-3. Jackson Bank of Commerce estimates that building a new branch office in the newly developed Guidar residential township will yield an annual expected return of 13 percent with an estimated standard deviation of 5 percent. The bank’s marketing department estimates that cash flows from the proposed Guidar branch will be mildly correlated (with a correlation coefficient of +0.3) with the bank’s other sources of cash flow. The expected annual return from the bank's existing facilities and other assets is 10 percent with a standard deviation of 3 percent. The branch will represent just 10 percent of Jackson’s total assets. Will the proposed branch increase Sullivan's overall rate of return? Its overall risk?The estimated total rate of return would be:E (R) = 0.10 (13%) + 0.90 (10%) = 10.3%The risk attached to this overall return rate would be:Thus ?? 2.89% and the branch will slightly increase the bank's expected return but slightly decrease its overall risk. The bank should proceed with this project.4-4. The following statistics and estimates were compiled by First Savings Bank of Talbot regarding a proposed new branch office and the bank itself:Branch Office Expected Return 16%Standard Deviation of Return = 7%Ban k’s overall expected return= 10%Standard deviation of bank’s return= 3%Branch Asset Value as a Percentof Total Bank Assets = 15%Correlation of Cash Flows = + 0.27What will happen to the Talbot’s total expected return and overall risk if the proposed new branch is adopted?The bank's total expected return is:E (R) = 0.15 (16%) + 0.85 (10%) = 10.9%The bank's risk exposure is:σ=And thus .0301 or 3.01%The proposed project raises the savings banks expected return slightly and does not affect the risk of the bank. This is a good project.4-5. First National Bank of Yukon is considering installing 3 ATMs in its westside branch. The new machines are expected to cost $48,000 apiece. Installation costs will amount to about $16,000 per machine. Each machine has a projected useful life of 10 years. Due to rapid growth in the westside district these three machines are expected to handle 180,000 transactions per year. On average, each cash transaction is expected to save $0.32 per transaction in check processing costs. If First National has a 12% cost of capital, should the bank proceed with this investment project? Year Savings1 $57,600 (.32*180,000)2 $57,6003 $57,6004 $57,6005 $57,6006 $57,6007 $57,6008 $57,6009 $57,60010 $57,600Initial Investment 192000 (48,000*3+16,000*3)Required Rate of Return 0.12Present Value of Future CashFlows $325,452.85Net Present Value $133,452.85The net present value of this project is positive. First National Bank of Yukon should add the ATM machines to the Westside.4-6. First State Security Bank is planning to set up its own web page to advertise its location and services on the Internet and to offer customers selected service options, such as paying recurring household bills, verification of account balances, and dispensing deposit account and loan application forms. What factors should First State take into account as it plans its own web page and Internet service menu? How can the bank effectively differentiate itself from other banks currently present on the Internet? How might the bank be able to involve its own customers in designing its web site and pricing its Internet service package?The bank should remember that while the internet is a relatively low cost way of expanding and allows customers to find the bank rather than the bank having to find customers, there are serious concerns about privacy. In addition, the Internet is not limited by geography and while there are thousands of potential customers, there are also many financial institutions around the world competing for customer deposits and loans. The bank needs to be aware that there are many bank web pages out there and that they will need to invest in employees with the technical expertise to manage the new web site well. One of the first things the bank needs to do is to take steps to protect its customers and let its customers know what its privacy and security policies are. Another step the bank can take is to start with a customer survey to find out what its customers want and need from the bank’s Internet services. They can run this as a contest and give away some small items to the customer with the best ideas for the web page and Internet service. This should help get customers involved in the design and implementation of the web page and may help the bank start building an online customer base.。