Reference no: EM133024719

1. Explain how a bank uses liability management to respond to a deposit outflow. Why do banks prefer liability management to asset management?

2. A bank with a two-year horizon has issued a one-year certificate of deposit for $50 million at an interest rate of 2 percent. With the proceeds, the bank has purchased a two-year Treasury note that pays 4 percent interest. What risk does the bank face in entering into these transactions? What would happen if all interest rates were to rise by 1 percent?

3. If lines of credit and other off-balance sheet activities do not, by definition, appear on the bank's balance sheet, how can they influence the level of liquidity risk to which the bank is exposed?

4. Suppose you are advising a bank on the management of its balance sheet. In light of the financial crisis of 2007-2009, what arguments might you make to convince the bank to hold additional capital?

5. Bank Y and Bank Z both have assets of $1 billion. Therefore, the return on assets for both banks is the same. However, Bank Y has liabilities of $800 million while Bank Z's liabilities are $900 million. In which bank would you prefer to hold an equity stake? Explain your choice.

6. Looking again at Bank A and Bank B in Problem 5, based on the information available, which bank do you think is at the greatest risk of insolvency? What other information might you use to assess the risk of default of these banks?

7. Why do you think that U.S. banks are prohibited from holding equity as part of their portfolios?