Bank Management Significant Types Of Funding By Commercial Banks

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1. Focus of GAP and Duration Gap and which is more inclusive.
2. Major types of funding for a commercial bank. Chapter 10
3. Meeting Legal Reserve Requirements. Chapter 11

I already uploaded the textbook "Bank Management", please discuss these three questions according to the textbook.

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Bank Management Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Bank Management 8e Timothy W. Koch University of South Carolina S. Scott MacDonald Southern Methodist University Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. This is an electronic version of the print textbook. Due to electronic rights restrictions, some third party content may be suppressed. Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. The publisher reserves the right to remove content from this title at any time if subsequent rights restrictions require it. For valuable information on pricing, previous editions, changes to current editions, and alternate formats, please visit www.cengage.com/highered to search by ISBN#, author, title, or keyword for materials in your areas of interest. Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Bank Management, Eighth Edition © 2015, 2010 Cengage Learning Timothy W. Koch and S. Scott MacDonald WCN: 02-200-203 Vice President, General Manager: Balraj S. Kalsi Product Director: Joe Sabatino Product Manager: Clara Goosman Content Developer: Theodore Knight Senior Product Assistant: Adele Scholtz Marketing Manager: Heather Mooney Managing Media Developer: Scott Fidler Manufacturing Planner: Kevin Kluck Intellectual Property Analyst: Christina Ciaramella Project Manager: Betsy Hathaway Art and Cover Direction, Production Management, and Composition: Integra Software Services Pvt. Ltd. Cover Image: © Tijana Lubura/Dreamstime.com ALL RIGHTS RESERVED. No part of this work covered by the copyright herein may be reproduced, transmitted, stored, or used in any form or by any means graphic, electronic, or mechanical, including but not limited to photocopying, recording, scanning, digitizing, taping, web distribution, information networks, or information storage and retrieval systems, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the publisher. For product information and technology assistance, contact us at Cengage Learning Customer & Sales Support, 1-800-354-9706. For permission to use material from this text or product, submit all requests online at www.cengage.com/permissions. Further permissions questions can be e-mailed to permissionrequest@cengage.com Library of Congress Control Number: 2014940665 ISBN: 978-1-133-49468-3 Cengage Learning 20 Channel Center Street Boston, MA 02210 USA Cengage Learning is a leading provider of customized learning solutions with office locations around the globe, including Singapore, the United Kingdom, Australia, Mexico, Brazil, and Japan. Locate your local office at: www.cengage.com/global. Cengage Learning products are represented in Canada by Nelson Education, Ltd. To learn more about Cengage Learning Solutions, visit www.cengage.com. Purchase any of our products at your local college store or at our preferred online store www.cengagebrain.com. Printed in the U nited States of America Print N umber: 01 Print Year: 2014 Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Dedication To Susan, Michala and Andy for all the joys of family. Timothy W. Koch To my family, Becky, Cassy, Erin, Jeff and Weston for their never-ending support and encouragement. S. Scott MacDonald Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xx Chapter 1 Banking and the Financial Services Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Global Financial Crisis of 2007–2009 2 How Do Banks Differ? 7 Organizational Structure 15 Financial Services Business Models 18 Too Big to Fail Banks 23 Different Channels for Delivering Banking Services Summary 26 Questions 27 Activities 28 References 28 25 Chapter 2 Government Policies and Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Historical Bank Regulation 32 Goals and Functions of Depository Institution Regulation 32 Ensure Safety and Soundness and Provide an Efficient and Competitive System New Charters 35 Shortcomings of Restrictive Bank Regulation 44 Maintaining Monetary Stability and the Integrity of the Payments System 44 Efficient and Competitive Financial System 50 Too Big To Fail 60 Summary 63 Questions 64 Activities 65 References 65 34 Chapter 3 Analyzing Bank Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Commercial Bank Financial Statements 69 The Relationship between the Balance Sheet and Income Statement The Return on Equity Model 91 Managing Risk and Returns 100 Financial Statement Manipulation 131 Summary 134 Questions 134 Problems 136 References 137 Appendix 139 90 vi i Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. viii Contents Chapter 4 Managing Noninterest Income and Noninterest Expense . . . . . . . . . . . . . . . . . . . . . . . 159 Noninterest Income 164 Noninterest Expense 169 Which Lines of Business and Customers Are Profitable? Summary 184 Questions 185 Activity 186 References 186 174 Chapter 5 The Performance of Nontraditional Banking Companies . . . . . . . . . . . . . . . . . . . . . . 189 The Disappearance of Large Investment Banks 191 Goldman Sachs Group, Inc., and Goldman Sachs Bank USA 193 The Financial Performance of Mutual of Omaha Bank 202 The Financial Performance of BMW Financial Services and BMW Bank of North America Summary 209 Questions 210 Activities 210 References 211 205 Chapter 6 Pricing Fixed-Income Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213 The Mathematics of Interest Rates 214 Simple versus Compound Interest 217 The Relationship between Interest Rates and Option-Free Bond Prices 219 Duration and Price Volatility 224 Recent Innovations in the Valuation of Fixed-Income Securities and Total Return Analysis Money Market Yields 233 Summary 236 Questions 237 Activities 239 References 240 229 Chapter 7 Managing Interest Rate Risk: GAP and Earnings Sensitivity . . . . . . . . . . . . . . . . . . . 241 Measuring Interest Rate Risk with GAP 245 Earnings Sensitivity Analysis 263 Income Statement GAP 272 Managing the GAP and Earnings Sensitivity Risk Summary 275 Questions 276 Activities 279 References 281 274 Chapter 8 Managing Interest Rate Risk: Economic Value of Equity . . . . . . . . . . . . . . . . . . . . . . . 283 Measuring Interest Rate Risk with Duration Gap 285 Economic Value of Equity Sensitivity Analysis 295 Earnings Sensitivity Analysis versus EVE Sensitivity Analysis: Which Model Is Better? 298 Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents ix A Critique of Strategies for Managing Earnings and Economic Value of Equity Sensitivity Yield Curve Strategies 303 Summary 305 Questions 305 Activity 307 References 307 301 Chapter 9 Using Derivatives to Manage Interest Rate Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309 Characteristics of Financial Futures 310 Speculation versus Hedging 319 Microhedging Applications 327 Macrohedging Applications 330 Using Forward Rate Agreements to Manage Rate Risk Basic Interest Rate Swaps as a Risk Management Tool Interest Rate Caps and Floors 342 Summary 357 Questions 357 Activities 361 References 364 333 335 Chapter 10 Funding the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 365 The Relationship between Liquidity Requirements, Cash, and Funding Sources Characteristics of Retail-Type Deposits 370 Characteristics of Large Wholesale Liabilities 379 Electronic Money 390 Check 21 392 Measuring the Cost of Funds 395 The Average Historical Cost of Funds 396 Funding Sources and Banking Risks 403 Summary 405 Questions 406 Problems 408 References 409 366 Chapter 11 Managing Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 413 Meeting Liquidity Needs 414 Reserve Balances at the Federal Reserve Bank 418 Required Reserves and Monetary Policy 418 Meeting Legal Reserve Requirements 421 Liquidity Planning 427 Traditional Aggregate Measures of Liquidity Risk 433 Basel III and the Liquidity Coverage Ratio 436 Longer-Term Liquidity Planning 437 Contingency Funding Plans 442 Summary 445 Questions 445 Activity 447 References 447 Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. x Contents Chapter 12 The Effective Use of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449 Why Worry about Bank Capital? 450 Risk-Based Capital Standards 451 What Constitutes Bank Capital? 458 Tangible Common Equity 461 What Is the Function of Bank Capital? 463 How Much Capital Is Adequate? 466 The Effect of Capital Requirements on Bank Operating Policies Characteristics of External Capital Sources 471 Contingent Convertible Capital 472 Capital Planning 474 Depository Institution Capital Standards 478 Changes to Capital Standards Under Basel III 478 Summary 481 Questions 481 Problems 483 References 484 467 Chapter 13 Overview of Credit Policy and Loan Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . 485 Recent Trends in Loan Growth and Quality 486 Measuring Aggregate Asset Quality 495 The Credit Process 497 Characteristics of Different Types of Loans 507 Summary 522 Questions 522 Problems 523 Activity 524 References 524 Chapter 14 Evaluating Commercial Loan Requests and Managing Credit Risk . . . . . . . . . . . . . . 527 Fundamental Credit Issues 529 Evaluating Credit Requests: A Four-Part Process 534 Credit Analysis Application: Wade’s Office Furniture 555 Managing Risk with Loan Sales and Credit Derivatives 570 Summary 574 Questions 574 Problems 577 References 580 Appendix I 582 Appendix II 584 Appendix III 585 Chapter 15 Evaluating Consumer Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587 Types of Consumer Loans 589 Consumer Credit Regulations 599 Credit Analysis 607 Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Contents x i Recent Risk and Return Characteristics of Consumer Loans Summary 620 Questions 620 Problems 622 Activities 622 References 623 617 Chapter 16 Managing the Investment Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625 Dealer Operations and the Securities Trading Account 627 Dodd–Frank Act Provisions Affecting Bank Investments 628 Objectives of the Investment Portfolio 629 Composition of the Investment Portfolio 633 Characteristics of Taxable Securities 634 Prepayment Risk on Mortgage-Backed Securities 645 Characteristics of Municipal Securities 653 Establishing Investment Policy Guidelines 658 What Are Suitable Investment Securities? 659 Active Investment Strategies 660 The Impact of Interest Rates on the Value of Securities with Embedded Options Comparative Yields on Taxable versus Tax-Exempt Securities 677 The Impact of the Tax Reform Act of 1986 681 Strategies Underlying Security Swaps 683 Summary 686 Questions 687 Problems 689 Activity 690 References 691 667 Chapter 17 Global Banking Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 693 U.S. Depository Institutions in the World Market 693 Impact of the Credit Crisis of 2007–2008 697 The European Community 703 Universal Banking Model 704 Organizational Structure of U.S. Banks with Foreign Operations International Financial Markets 708 International Lending 711 Foreign Exchange Activities 717 Summary 721 Questions 722 References 723 706 Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 725 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 753 Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Copyright 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Preface The world of banking has changed dramatically since 2007 when many large financial institutions around the world failed and were bailed out by their central governments. The United States and global economies subsequently fell into recession. Millions of Americans lost their jobs, and household net worth plummeted with the decline in housing and the value of investments. The ongoing recovery continues to be slow and painful for many. Not surprisingly, the reputations of many banks and the banking industry in general have suffered. Yet, if done correctly, banking is a critical driver of economic activity and a noble profession. It involves the processing of payments, accepting deposits and making loans, safekeeping documents and valuable items, providing guarantees and performance bonds, offering cash management, brokerage and insurance services, and providing securities underwriting and market-making services. So, what caused a breakdown in the financial services industry leading to the recent financial crisis? In 2011, the National Commission on the Causes of the Financial and Economic Crisis in the United States published a report that said both senior management at large financial institutions and key government officials ignored warning signals and inadequately managed risks; and that the crisis was avoidable.1 It attributed the crisis to: (1) risky lending via subprime mortgages; (2) trading activities at large institutions; (3) unregulated derivatives markets; and (4) problems with lending via repurchase agreements, among other factors. In response, the U.S. Congress passed the Dodd–Frank Wall Street Reform and Consumer Protection Act in June 2010 (commonly labeled the Dodd– Frank Act), which has produced and continues to produce numerous changes in the regulation of financial firms. The global crisis has similarly brought about changes in regulations at financial firms in other industrialized countries. One of the most unusual results of the crisis and subseq ...
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