   Chapter 11, Problem 6PA

Chapter
Section
Textbook Problem

Happy Bank starts with $200 in bank capital. It then accepts$800 in deposits. It keeps 12.5 percent (1/8th) of deposits in reserve. It uses the rest of its assets to make bank loans.a. Show the balance sheet of Happy Bank.b. What is Happy Bank’s leverage ratio?c. Suppose that 10 percent of the borrowers from Happy Bank default and these bank loans become worthless. Show the bank’s new balance sheet.d. By what percentage do the bank’s total assets decline? By what percentage does the bank’s capital decline? Which change is larger? Why?

Sub part (a):

To determine

The balance sheet and leverage ratio of the bank.

Explanation

The banks are the financial institutions that accept deposits from the general public and provide loans to the general public in order to meet their various needs. The leverage ratio is the ratio of the bank’s total assets to the total capital of the bank. When the total assets of the bank are declined by a given percentage, it will have the multiple times the leverage ratio’s impact on the value of the capital of the bank. That is, the value of the capital of the bank declines by the percentage decline multiplied with the leverage ratio.

Here, it is given that the bank starts with $200 capital, accepts$800 deposits. It keeps 12.5 percent (1/8) of its deposits in the reserves of the bank. Thus, the remaining 87...

Sub part (b):

To determine

The balance sheet and leverage ratio of the bank.

Sub part (c):

To determine

The balance sheet and leverage ratio of the bank.

Subpart (d):

To determine

The balance sheet and leverage ratio of the bank.

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