Problem set #4 Solution - ECON 136, FALL 2009 PROBLEM SET 4...

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ECON 136, FALL 2009 PROBLEM SET 4 SOLUTIONS Question 1: Bank Runs a) If all investors keep their money in the bank until t=2 then all of them will get their promised 5% return. Notice that the value of the CMOs at t=2 is $210, which is exactly the value of the deposits plus the promised 5% return. So if you believe all the other investors will keep their money in the bank until t=2 then you should also do it. Given that all other investors think like you then no bank run will take place. b) In this case you should also withdraw your money in t=1. In period t=1, the total bank assets are equal to $180 ($160 in CMOs and $20 in cash). Notice that if 180 investors withdraw their money in t=1 then the bank will have no assets in t=2 (that is, it will use all the CMOs and cash to pay $1 for each investor that withdrew) and it will be unable to make any payment to the other 20 investors (that is, they will receive zero at t=2). So, it is better for you to also withdraw in t=1 and receive some positive value. Therefore, if the other investors think like you, a bank run will take place in t=1. c)
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Problem set #4 Solution - ECON 136, FALL 2009 PROBLEM SET 4...

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