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Chapter 11 - Answers to Chapter 11 Questions 1 A depository...

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Answers to Chapter 11 Questions 1. A depository institution is a financial intermediary that obtains a significant proportion of its funds from customer deposits. Industrial corporations tend to obtain a greater proportion of their funds from stockholders, bondholders, and other types of creditors. 2. The major sources of funds for commercial banks in the U.S. are reported on the liability side of the balance sheet: Deposits: Transaction accounts (demand deposit and NOW accounts); and Time deposits (small savings accounts and time deposits over $100,000). Borrowed funds: Federal funds; Repurchase agreements; Eurodollar deposits; bankers acceptances, etc. Equity: Common stock; long-term subordinated debt. The major uses of funds for commercial banks in the U.S. are reported on the asset side of the balance sheet: Loans: Commercial and industrial; Real estate and consumer. Securities: Government (Federal and municipal) securities. Cash: Vault cash; Reserves at the Federal Reserve Bank. 3. The answer to this S&P question will vary depending on the date of the assignment. 4. According to Figure 11-4, the four asset types are securities, business loans, mortgages, and consumer loans. Over the longer term, there has been a drop in securities and an increase in mortgages. More recently, we have seen a drop in business loans an increase in securities holdings, and a continued increase in mortgages. Among the reasons for this changing composition are the growth in the commercial paper market, the securitization of mortgages, and the credit crunch of 1989-92. Credit or default exposure is the primary risk from these assets. 5. Investment securities consist of items such as interest-bearing deposits purchased from other FIs, federal funds sold to other banks, repurchase agreements, U.S. Treasury and agency securities, municipal securities issued by states and political subdivisions, mortgage-backed securities, and other debt and equity securities. Investment securities generate interest income for the bank and are also used for trading and liquidity management purposes. Many investment securities held by banks are highly liquid, have low default risk, and can usually be traded in secondary markets. 6. According to Table 11-2, the principal sources were deposits, borrowings and other liabilities. Of these, deposits comprised 72.8% of total liabilities. The deposits consist of transaction accounts such as non interest bearing deposits and interest bearing NOW accounts and nontransaction accounts in the form of small savings accounts (time deposits) and large negotiable certificates of deposits. The short term nature of these liabilities exposes the banks to interest rate risk. 66
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7. Transaction accounts are checkable deposits that either bear no interest (so-called demand deposits) or are interest bearing (most commonly called negotiable order of withdrawal accounts or NOW accounts). Since their introduction in 1980, interest-bearing checking accounts, especially NOW accounts, have dominated the transaction accounts of banks. Noninterest-bearing
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