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Sara Trojacek FINC 3321 Part 6 Integrative Problem Forecasting Bank Performance As an analyst of a medium-sized commercial bank, you have been asked...

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Sara Trojacek FINC 3321 Part 6 Integrative Problem Forecasting Bank Performance As an analyst of a medium-sized commercial bank, you have been asked to forecast next year’s performance. In June you were provided with information about the sources and uses of funds for the upcoming year. The bank’s sources of funds for the upcoming year are as follows: SOURCES OF FUNDS DOLLAR AMOUNT (IN MILLIONS) INTEREST RATE TO BE OFFERED Demand deposits $5,000 0% Time deposits 2,000 6% 1-year NCDs 3,000 T-bill rate + 1% 5-year NCDs 2,500 1-year NCD rate + 1% The bank also has $1 billion in capital. The bank’s uses of funds for the upcoming year are as follows: USES OF FUNDS DOLLAR AMOUNT (IN MILLIONS) INTEREST RATE LOAN LOSS PERCENTAGE Loans to small businesses $4,000 T-bill rate + 6% 2% Loans to large businesses 2,000 T-bill rate + 4% 1 Consumer loans 3,000 T-bill rate + 7% 4 Treasury bills 1,000 T-bill rate 0 Treasury bonds 1,500 T-bill rate + 2% 0 Corporate bonds 1,100 Treasury bond rate + 2% 0 The bank also has $900 million in fixed assets. The interest rates on loans to small and large businesses are tied to the T-bill rate and will change at the beginning of each new year. The forecasted Treasury bond rate is tied to the future T-bill rate, based on the expectation that an upward-sloping yield curve will exist at the beginning of next year. The corporate bond rate is tied to the Treasury bond rate, allowing for a risk premium of 2 percent. Consumer loans will be provided at the beginning of next year, and interest rates will be fixed over the lifetime of the loan. The remaining time to maturity on all assets except T-bills exceeds three years. As the one- year T-bills mature, the funds are to be reinvested in new one-year T-bills (all T-bills are to be purchased at the beginning of the year). The bank’s loan loss percentage reflects the percentage of bad loans. Assume that no interest will be received on these loans. In addition, assume that this percentage of loans will be accounted for as loan loss reserves (assume that they should be subtracted when determining before-tax income). The bank has forecasted its noninterest revenues to be $200 million and its noninterest expenses to be $740 million. A tax rate of 34 percent can be applied to the before-tax income in order to estimate after-tax income. The bank has developed the following probability distribution for the one-year T-bill rate that will exist as of the beginning of next year:
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POSSIBLE T-BILL RATE PROBABILITY 8% 30% 9 50 10 20 Questions 1. Using the information provided, determine the probability distribution of return on assets (ROA) for next year by completing the following table: INTEREST RATE SCENARIO (POSSIBLE T- BILL RATE) FORECASTED ROA PROBABILITY 8% 9 10 2. Will the bank’s ROA next year be higher or lower if market interest rates are higher? (Use the T-bill rate as a proxy for market interest rates.) Why? The information provided did not assume any required reserves. Explain how including required reserves would affect the forecasted interest revenue, ROA, and ROE. 3. The bank is considering a strategy of attempting to attract an extra $1 billion as one year negotiable certificates of deposit (NCDs) to replace $1 billion of five-year NCDs. Develop the probability distribution of ROA based on this strategy: INTEREST RATE SCENARIO FORECASTED ROA BASED ON THE STRATEGY OF INCREASING ONE-YEAR NCDS PROBABILIT Y 8% 9 10 4. Is the bank’s ROA likely to be higher next year if it uses the strategy of attracting more one-year NCDs? 5. What would be an obvious concern about a strategy of using more one-year NCDs and fewer five-year NCDs beyond the next year? 6. The bank is considering a strategy of using $1 billion to offer additional loans to small businesses instead of purchasing T-bills. Using all the original assumptions provided, determine the probability distribution of ROA (assume that noninterest expenses would not be affected by this change in strategy).
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8398020.xlsx

Answer 1
Head
Small Business
Large Business
Consumer Loan
Treasury Bills
Treasury Bonds
Cooprate Bonds T bill rate 8%
T bill rate 9%
T bill rate 10%
Laon Amt Loan loss Net Loans
Int Rate
Interest...

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