Problems for Commercial Bank Management

Lecture 2 Financial Statements

2.1. Suppose that a bank holds cash in its vault of $1.4 million, short-term
government securities of $12.4 million, privately issued money market instruments of
$5.2 million, deposits at the Federal Reserve banks of $20.1 million, cash items in the
process of collection of $0.6 million, and deposits placed with other banks of $16.4
million. How much in primary reserves does this bank hold? In secondary reserves?

2.2. Suppose a bank has an allowance for loan losses of $1.25 million at the
beginning of the year, charges current income for a $250,000 provision for loan
losses, charges off worthless loans of $150,000, and recovers $50,000 on loans
previously charged off. What will be the balance in the allowance for loan losses at
year-end?

2.3. Jasper National Bank has just submitted its Report of Condition to the FDIC.
Please fill in the missing items from its statement shown below (all figures in
millions of dollars):

Report of Condition
Total assets $2,500
Cash and due from Depository Institutions 87
Securities 233
Federal Funds Sold and Reverse Repurch. 45
Gross Loans and Leases 1900
1 Loan Loss Allowance 200
Net Loans and Leases 1700
Trading Account Assets 20
Bank Premises and Fixed Assets 25
Other Real Estate Owned 15
Goodwill and Other Intangibles 200
All Other Assets 175
Total Liabilities and Capital 2,500
Total Liabilities 2260
Total Deposits 1600
Federal Funds Purchased and Repurchase Agreements. 80
Trading Liabilities 10
Other Borrowed Funds 50
Subordinated Debt 480
All Other Liabilities 40
Total Equity Capital 240
Perpetual Preferred Stock 2
Common Stock 24
Surplus 144
Undivided Profit 70

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2.4. Along with the Report of Condition submitted above, Jasper has also prepared a
Report of Income for the FDIC. Please fill in the missing items from its statement
shown below (all figures in millions of dollars):
Report of Income

Total Interest Income $120

Total Interest Expense 80
Net Interest Income 40
Provision for Loan and Lease Losses 4
Total Noninterest Income 58
Fiduciary Activities 8
Service Charges on Deposit Accounts 6
Trading Account Gains and Fees 14
Additional Noninterest Income 30
Total Noninterest Expense 77
Salaries and Benefits 47
Premises and Equipment Expense 10
Additional Noninterest Expense 20
Pretax Net Operating Income 17
Securities Gains (Losses) 1
Applicable Income Taxes 5
Income Before Extraordinary Income 13
Extraordinary Gains – Net 2
Net Income 15

2.5. If you know the following figures:

Total Interest Income $140 Provision for Loan Loss $5

Total Interest Expenses 100 Income Taxes 5
Increases in bank’s undivided
Total Noninterest Income 15 profits 6
Total Noninterest Expenses 35

Please calculate these items:

Net Interest Income
Net Noninterest Income
Pretax net operating income
Net Income After Taxes
Total Operating Revenues
Total Operating Expenses
Dividends paid to Common Stockholders

2.6. The Mountain High Bank has Gross Loans of $750 million with an ALL
account of $45 million. Two years ago the bank made a loan for $10 million to
finance the Mountain View Hotel. Two million in principal was repaid before the

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borrowers defaulted on the loan. The Loan Committee at Mountain High Bank
believes the hotel will sell at auction for $7 million and they want to charge off the
remainder immediately.
a. Net loans?
b. After charge-off, Gross Loans, ALL and Net Loans?
c. If the Mountain View Hotel sells at auction for $8 million, how with the affect the
pertinent balance sheet accounts?

2.7. You were informed that a bank’s latest income and expense statement
contained the following figures (in $ millions):

Net Interest Income $700

($300
Net Noninterest Income )
Pretax net operating income $372
Security gains $10
Increases in bank’s
Undivided Profit $200

Suppose you also were told that the bank’s total interest income is twice as large as its
total interest expense and its noninterest income is three-fourths of its noninterest
expense. Imagine that its provision for loan losses equals 2 percent of its total interest
income, while its taxes generally amount to 30 percent of its net income before
income taxes. Calculate the following items for this bank’s income and expense
statement:

Total Interest Income (TII) and Total Interest Expense(TIE):

Total Noninterest Income (TNI) and Total Noninterest Expense(TNE):
Provision for Loan Losses
Taxes
Dividends

Lecture 3 Deposits

3.1. A bank determines from an analysis of its cost-accounting figures that for each
$500 minimum-balance checking account it sells account processing and other
operating costs will average $4.87 per month and overhead expenses will run an
average of $1.21 per month. The bank hopes to achieve a profit margin over these
particular costs of 10 percent of total monthly costs. What monthly fee should it
charge a customer who opens one of these checking accounts?

4.87 + 1.21 + 10%(4.87 + 1.21) = 6.69

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3.2. Use the APY formula required by the Truth in Savings Act for the following
calculation. Suppose that a customer holds a savings deposit in a savings bank for a
year. The balance in the account stood at $2,000 for 180 days and $100 for the
remaining days in the year. If the Savings bank paid this depositor $8.50 in interest
earnings for the year, what APY did this customer receive?

Balance = (2000 x 180 + 100 x 185)/365 = 1036.99

APY = 8.5/1036.99 = 0,82%

=> cần phải tính Average balance account trước: Balance = (2000 x 180 + 100 x
185)/365 = 1036.99
Sau đó lắp vào công thức

3.3. Monica Lane maintains a savings deposit with Monarch Credit Union. This
past year Monica received $10.75 in interest earnings from her savings account. Her
savings deposit had the following average balance each month:

January $400 July $350

February 250 August 425
March 300 September 550
April 150 October 600
May 225 November 625
June 300 December 300

What was the annual percentage yield (APY) earned on Monica’s savings account?

Balance = (400x31 + 250x 28 +…)/365 = 373.56

APY = 10.75/373.56 = 2,88%

3.4. The National Bank of Mayville quotes an APY of 3.5 percent on a one-year
money market CD sold to one of the small businesses in town. The firm posted a
balance of $2,500 for the first 90 days of the year, $3,000 over the next 180 days, and
$4,500 for the remainder of the year. How much in total interest earnings did this
small business customer receive for the year?

Balance = (2500x90 + 3000x180 + 4500x95) = 3267,12

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Interest = 3267.12 x 3.5% = 114,35

3.5. Gold Mine Pit Savings Association finds that it can attract the following
amounts of deposits if it offers new depositors and those rolling over their maturing
CDs the interest rates indicated below:

Expected Volume Rate of Interest

of New Deposits Offered Depositors
$10 million 3.00%
15 million 3.25
20 million 3.50
26 million 3.75
28 million 4.00

Management anticipates being able to invest any new deposits raised in loans yielding
6.25 percent. How far should this thrift institution go in raising its deposit interest rate
in order to maximize total profits (excluding interest costs)?

Lecture 4
4.1 From the descriptions below please identify what type of business loan is
involved.
a. A temporary credit supports construction of homes, apartments, office buildings,
and other permanent structures.
b. A loan is made to an automobile dealer to support the shipment of new cars.
c. Credit extended on the basis of a business’s accounts receivable.
d. The term of an inventory loan is being set to match the length of time needed to
generate cash to repay the loan.
e. Credit extended up to one year to purchase raw materials and cover a seasonal need
for cash.
f. A security dealer requires credit to add new government bonds to his security
portfolio.
g. Credit granted for more than a year to support purchases of plant and equipment.
h. A group of investors wishes to take over a firm using mainly debt financing.
i. A business firm receives a three-year line of credit against which it can borrow,
repay, and borrow again if necessary during the loan’s term.
j. Credit extended to support the construction of a toll road.
4.2 From the data given in the following table, please construct as many of the
financial ratios discussed in this chapter as you can and then indicate the dimension of
a business firm’s performance each ratio represents.

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* Annual principal payments on bonds and notes payable total $55. The firm’s
marginal tax rate is 35 percent.

4.3 Pecon Corporation has placed a term loan request with its lender and submitted
the following balance sheet entries for the year just concluded and the pro forma
balance sheet expected by the end of the current year. Construct a pro forma
Statement of Cash Flows for the current year using the consecutive balance sheets and
some additional needed information. The forecast net income for the current year is
$225 million with $50 million being paid out in dividends. The depreciation expense
for the year will be $100 million and planned expansions will require the acquisition
of $300 million in fixed assets at the end of the current year. As you examine the pro
forma Statement of Cash Flows, do you detect any changes that might be of concern
either to the lender’s credit analyst, loan officer, or both?

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4.4 As a loan officer for Sun Flower National Bank, you have been responsible for
the bank’s relationship with USF Corporation, a major producer of remote-control
devices for activating television sets, DVDs, and another audio-video equipment. USF
has just filed a request for renewal of its $10 million line of credit, which will cover
approximately nine months. USF also regularly uses several other services sold by the
bank. Applying customer profitability analysis (CPA) and using the most recent year
as a guide, you estimate that the expected revenues from this commercial loan
customer and the expected costs of serving this customer will consist of the following:

The bank’s credit analysts estimated the customer probably will keep an
average deposit balance of $2,125,000 for the year the line is active. What is the
expected net rate of return from this proposed loan renewal if the customer actually
draws down the full amount of the requested line for nine months? What decision
should the bank make under the foregoing assumptions? If you decide to turn down
this request, under what assumptions regarding revenues, expenses, and customer
deposit balances would you be willing to make this loan?

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4.5 In order to help fund a loan request of $10 million for one year from one of its
best customers, Lone Star Bank sold negotiable CDs to its business customers in the
amount of $6 million at a promised annual yield of 3.50 percent and borrowed $4
million in the Federal funds market from other banks at today’s prevailing interest rate
of 3.25 percent.
Credit investigation and recordkeeping costs to process this loan application
were an estimated $25,000. The Credit Analysis Division recommends a minimal 1
percent risk premium on this loan and a minimal profit margin of one-fourth of a
percentage point. The bank prefers using cost-plus loan pricing in this case. What loan
rate would it charge?

Lecture 5

5.1 Mr. and Mrs. Napper are interested in funding their children's college education
by taking out a home equity loan in the amount of $24,000. Eldridge National Bank is
willing to extend a loan, using the Napper's home as collateral. Their home has been
appraised at $110,000, and Eldridge permits a customer to use no more than 70
percent of the appraised value of the home as a borrowing base. The Nappers still owe
$60,000 on the first mortgage against their home. Is there enough residual value left
in the Nappers’ home to support their loan request? How could the lender help them
meet their credit needs?

5.2 Ben James has just been informed by a finance company that he can access a
line of credit of no more than $75,000 based upon the equity value in his home.
James still owes $125,000 on a first mortgage against his home and $25,000 on a
second mortgage claim against the home, which was incurred last year to repair the
roof and driveway. If the appraised value of James’s residence is $300,000, what
percentage of the home's estimated market value is the lender using to determine
James’s maximum available line of credit?

5.3 Jamestown Savings Bank, in renewing its credit card customers finds that of
those customers scoring 40 points or less on its credit-scoring system, 35 percent (or a
total of 10,615 credit customers) turned out to be delinquent credits resulting in total
losses. This group of bad credit card loans averaged $6,800 in size per customer
account. Examining its successful credit accounts Jamestown finds that 12% of its
good customers (or a total of 3,640 customers) scored 40 points or less on the bank’s
scoring system. These low scoring but good accounts generated about $1,700 in
revenues each. If Jamestown’s credit card division follows the decision rule of
granting credit cards only to those customers scoring more than 40 points and future
credit accounts generate about the same average revenues and losses, about how much
can the bank expect to save in net losses.

5.4 The Lathrop family needs some extra funds to put their two children through
college starting this coming fall and to buy a new computer system for a part-time

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home business. They are not sure of the current market value of their home, though
comparable 4-bedroom homes are selling for about $410,000 in the neighborhood.
The Monarch University Credit Union will loan 75 percent of the property’s appraised
value, but the Lathrops still owe $265,000 on their home mortgage and home
improvement loan combined. What maximum amount of credit is available to this
family should it elect to seek a home equity credit line?

5.5 The Crockett family has asked for a 30-year mortgage in the amount of
$325,000 to purchase a home. At a 7 percent loan rate, what is the required monthly
payment?

5.6 The Watson family has been planning a vacation to Europe for the past two
years. Gratton Savings agrees to advance a loan of $7,200 to finance the trip provided
the Watsons pay the loan back in 12 equals monthly installments. Gratton will charge
an add-on loan rate of 6%. How much in interest will the Watsons pay under the add-
on loan rate method? What is the amount of each required monthly payment? What
is the effective loan rate in this case?

5.7 Jane Zahrley’s request for a four-year automobile loan for $33,000 has been
approved. Reston Center Bank will require equal monthly installment payments for
48 months. The bank tells Jane that she must pay a total of $5,500 in finance charges.
What is the loan’s APR?

5.8 Mary Cantrary is offered a $1,600 loan for a year to be paid back in equal
quarterly installments of $400 each. If Mary is offered the loan at 8 percent simple
interest, how much in total interest charges will she pay? Would Mary be better off
(in terms of lower interest cost) if she were offered the $1,600 at 6 percent simple
interest with only one principal payment when the loan reaches maturity? What
advantage would this second set of loan terms have over the first set of loan terms?

Lecture 6
6-1. A government bond is currently selling for $1,195 and pays $75 per year in interest
for 14 years when it matures. If the redemption value of this bond is $1,000, what is its yield
to maturity if purchased today for $1,195?

1195 = 75/(1+YTM) + … + 1075/(1+YTM)^14 Excel

YTM = 5.47

6-2. Suppose the government bond described in problem 1 above is held for five years
and then the savings institution acquiring the bond decides to sell it at a price of $940. Can
you figure out the average annual yield the savings institution will have earned for its five-
year investment in the bond?

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6-3. U.S. Treasury bills are available for purchase this week at the following prices (based
upon $100 par value) and with the indicated maturities:

a. $97.25, 182 days.

b. $95.75, 270 days.
c. $98.75, 91 days.

Calculate the bank discount rate (DR) on each bill if it is held to maturity. What is the
equivalent yield to maturity (sometimes called the bond-equivalent or coupon-equivalent
yield) on each of these Treasury Bills?

6-4. Farmville Financial reports a net interest margin of 2.75 percent in its most recent
financial report, with total interest revenue of $95 million and total interest costs of $82
million. What volume of earning assets must the bank hold? Suppose the bank’s interest
revenues rise by 5 percent and its interest costs and earnings assets increase by 9 percent.
What will happen to Farmville’s net interest margin?

Earning assets = (95-82)/0.0275 = 472.73

=(95x1.05 – 82x1.09)/(473x1.09) = 2.01%

6-5. If a credit union’s net interest margin, which was 2.50 percent, increases 10 percent
and its total assets, which stood originally at $575 million, rise by 20 percent, what change
will occur in the bank's net interest income?

6-6. The cumulative interest rate gap of Poquoson Savings Bank increases 60 percent
from an initial figure of $25 million. If market interest rates rise by 25 percent from an initial
level of 3 percent, what changes will occur in this thrift’s net interest income?

6-7. New Comers State Bank has recorded the following financial data for the past three
years (dollars in millions):

Current Year Previous Year Two Years Ago

Interest revenues $82 $80 $78
Interest expenses 64 66 68
Loans (excluding nonperforming) 450 425 400
Investments 200 195 200
Total deposits 450 425 400
Money market borrowings 150 125 100

What has been happening to the bank’s net interest margin? What do you think caused the
changes you have observed? Do you have any recommendations for New Comers’
management team?

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6-8. First National Bank of Bannerville has posted interest revenues of $63 million and
interest costs from all of its borrowings of $42 million. If this bank possesses $700 million in
total earning assets, what is First National’s net interest margin? Suppose the bank’s interest
revenues and interest costs double, while its earning assets increase by 50 percent. What
will happen to its net interest margin?

6.9. Peoples’ Savings Bank has a cumulative gap for the coming year of + $135 million,
and interest rates are expected to fall by two and a half percentage points. Can you
calculate the expected change in net interest income that this thrift institution might
experience? What change will occur in net interest income if interest rates rise by one and a
quarter percentage points?

6.10 Suppose Carroll Bank and Trust reports interest-sensitive assets of $570 million and
interest-sensitive liabilities of $685 million. What is the bank’s dollar interest-sensitive gap?
Its relative interest-sensitive gap and interest-sensitivity ratio?

6.11. Suppose that a savings institution has an average asset duration of 2.5 years and an
average liability duration of 3.0 years. If the savings institution holds total assets of $560
million and total liabilities of $467 million, does it have a significant leverage-adjusted
duration gap? If interest rates rise, what will happen to the value of its net worth?

6.12. Stilwater Bank and Trust Company has an average asset duration of 3.25 years and
an average liability duration of 1.75 years. Its liabilities amount to $485 million, while its
assets total $512 million. Suppose that interest rates were 7 percent and then rise to 8
percent. What will happen to the value of the Stilwater bank's net worth as a result of a
decline in interest rates?

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