Financial Markets and Institutions

Chuhai College of Higher Education

2013
Exercise 3
1. In the mid-to late 1970s, the yen appreciated relative to the dollar even though
Japans inflation rate was higher than Americas. How can this be explained by an
improvement in the productivity of Japanese industry relative to American
industry?
Ans:
EventhoughtheJapanesepricelevelroserelativetotheAmerican,theyen
appreciatedbecausetheincreaseinJapaneseproductivityrelativetoAmerican
productivitymadeitpossiblefortheJapanesetocontinuetoselltheirgoodsata
profitatahighvalueoftheyen.
2. An investor in Canada purchased 100 shares of IBM on January 1 at $93.00 per
share. IBM paid an annual dividend of $0.72 on December 31. The stock was sold
that day as well for $100.25. The exchange rate was $0.68 per Canadian dollar on
January 1 and $0.71 per Canadian dollar on December 31. What is the investors
total return in Canadian dollars?
Ans:
Thepriceofeachshareis$93.00/$0.68136.76Canadiandollars.
Thedividendis$0.72/$0.711.014Canadiandollars
Thesalepriceis$100.25/$0.71141.20Canadiandollars
Thereturn(141.201.014136.76)/136.760.03988
3. A one-year CD in Europe is currently paying 5%, and the exchange rate is
currently 0.99 euros per dollar. If you believe the exchange rate will be 1.04 euros
per dollar one year from now, what is the expected return in terms of dollars?
Ans:
Expectedreturn0.05((1.040.99)/0.99)
5%5.05%0.05%

4. If the bank you own has no excess reserves and a sound customer comes in asking
for a loan, should you automatically turn the customer down, explaining that you
dont have any excess reserves to loan out? Why and why not? What options are

available for you to provide the funds your customer needs?

Ans:
No.Whenyouturnacustomerdown,youmaylosethatcustomersbusiness
forever,whichisextremelycostly.Instead,youmightgooutandborrowfrom
otherbanks,corporations,ortheFedtoobtainfundssothatyoucanmakethe
customersloan.Alternatively,youmightsellnegotiableCDsorsomeofyour
securitiestoacquirethenecessaryfunds.
5. A bank estimates the demand deposits are, on average, $100 million with a
standard deviation of $5 million. The bank wants to maintain a minimum of 8% of
deposits in reserves at all times. What is the highest expected level of deposits
during the month? What reserves do they need to maintain? Use a 99% confidence
level.
Ans:
Thehighestthatdemanddepositswillreach,with99%confidence,is$100M3
$5million,or$115million.Tomaintain8%asreservesagainstthispossibility,
theymustmaintain4115M0.08$9.2million.
Abetterapproachwouldbetoincrease/decreasereservesasdepositsare
received/withdrawn,ratherthanmaintain$9.2millionagainstthepossibilityof
$115Mindeposits.

6. New Bank started its first day of operations with $6 million in capital. $100
million in checkable deposits is received. The bank issues a $25 million
commercial loan and another $25 million in mortgages, with the following terms:

Mortgages: 100 standard 30-year fixed-rate mortgages with a nominal annual

rate of 5.25% each for $250,000

Commercial loan: 3-year loan, simple interest paid monthly at 0.75% per
month
If required reserves are 8%, what does the bank balance sheets look like? Ignore
any loan loss reserves.
Ans:
Assets

Liabilities

RequiredReserves

$8million

CheckableDeposits

$100million

ExcessReserves

$48million

BankCapital

$6million

Loans

$50million

7. How did competitive forces lead to the repeal of the Glass-Steagall Acts
separation of the banking and the securities industries?
Ans:
Brokeragefirmsbegantoengageinthetraditionalbankingbusinessofissuing
depositinstruments,whileforeignbankactivitiesintheUnitedStatesfurther
erodedthecompetitivepositionofU.S.banks.ThisledtotheFederalReserves
allowingbankholdingcompaniestoentertheunderwritingbusinessthrougha
loopholeinGlassSteagallinordertokeepthemcompetitive.Finally,legislation
in1999waspassedtorepealGlassSteagall.