Tutorial Solutions Week 2 - Tutorial Solutions Week 2...

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Tutorial Solutions Week 2 Chapter 1 1.2 List three broad functions of commercial banks. What other financial institutions compete with banks in providing these services to the public? The main functions of banks are (1) payments, (2) intermediation, and (3) other financial services. Numerous financial institutions compete with banks in providing these services. For example, other depository institutions provide payments mechanisms as do money market mutual funds and many securities brokerage firms. The Commonwealth Bank Cash Management Account (CMA) is an excellent example. 1.3 What is the main goal of a commercial bank? How does profitability of a bank and the risks it faces affect this goal? Banks seek to maximise the market value of equity of common shareholders. Of course, profits on operations will increase share price, holding all risks constant. In practice, banks face a variety of risks, such as credit risk on loans, interest rate risk associated with changes in the value of its financial assets and liabilities as interest rate change, liquidity risk that occurs because assets might have to be sold at a relatively large discount from their original value, operations risk that their expenses might be too high, and so on. There is an expected tradeoff between risk and return. In the late 1990s, banks increased their risk by taking on more real estate loans. Because the economy was prosperous, the increased risk paid-off in terms of higher profits. 1.6 What constraints do banks face in achieving their goals(s)?
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