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im06 - Chapter 12 Managing Liabilities and the Cost of...

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Chapter 12 Managing Liabilities and the Cost of Funds Chapter Objectives 1. Describe the composition and characteristics of bank liabilities. 2. Introduce the Federal Reserve System's Functional Cost and Profit Analysis data. 3. Describe how to estimate the average cost of transactions accounts. 4. Demonstrate how Eurodollar deposits and loans originate. 5. Provide a method for calculating the marginal cost of a single source of bank funds 6. Present an application of the calculation of the weighted-average marginal cost of funds. 7. Describe the usefulness and interpretation of historical cost of funds analysis. 8. Examine the role and impact of Federal deposit insurance. Key Concepts 1. Banks can pay market rates of interest on virtually all deposits except commercial demand deposits. 2. Depositors have become increasingly rate conscious and move their balances between institutions on the basis of relative yields offered. 3. Banks price transactions accounts and small time deposits by requiring minimum balances before paying interest, charging monthly maintenance fees or service charges, and imposing per check charges. 4. Most large transactions handled by banks are settled in immediately available funds, which include collected deposits at banks and deposit balances held at Federal Reserve Banks. 5. Eurodollar deposits are dollar-denominated deposits in banks located outside the United States. They arise when customers open a Eurodollar account outside the U.S., but the deposit is supported by dollar balances at a bank located in the U.S. 6. Bank borrowing from the Federal Reserve discount window takes the form of adjustment credit, seasonal credit, or emergency credit. Only short-term adjustment credit is sensitive to interest rates. Seasonal borrowing is being phased out and regulators are under pressure to reduce emergency credit provided. 7. Average interest costs are based on historical performance. They provide no information as to whether future interest costs will rise or fall. Average costs should be used in evaluating historical performance, but not current pricing decisions. 8. The marginal cost of debt is the effective cost paid to acquire one additional dollar of investable funds. The marginal cost of equity is a measure of the minimum acceptable rate of return required by shareholders. 9. Banks should use marginal costs as inputs in their deposit and asset pricing decisions. 10. The composition and cost of bank funds are closely associated with a banks risk profile. The lower the amount of core deposits, the higher is the cost of funds and the greater is liquidity risk. 11. The FDIC uses either a payout option or purchase and assumption option in handling a failed bank. It is supposed to choose the one that is lowest cost. Under the payout option, uninsured deposits are not paid in full by the FDIC, while uninsured deposits are paid in full under the purchase and assumption option. This creates the potential for discriminatory treatment.
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Teaching Suggestions Students enjoy debating the merits of different transactions account pricing schemes. Have them identify the
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