Question

1) Show the balance sheet for a hypothetical bank balance sheet that has common stock with book value of 20, loans of 200, Treasury bonds of 20, cash of 10, reserves at the Fed of 30, and deposits. (You must compute the amount of deposits, given that these are the only items on this balance sheet.)

2) What happens to this balance sheet if it experiences a net reduction in deposits of 20.

(a) In this setting, suppose that the reserve requirement is 10% of transaction deposits. After this net reduction is the bank in compliance with its reserve requirement? Explain.

(b) Explain two ways that this bank can come into compliance, and show the bank’s balance sheet in both cases.

(c) Explain what the effect of this bank’s actions is on the federal funds rate in the two cases.

Answer 1

Balance sheet of Hypothethical Bank

Liabilities	Amount	Assets	Amount
Common Stock	20	Loans	200
Deposits	240	Treasury Bonds	20
(260-20)		Cash	10
		Reserves at FED	30
Total	260		260

2)

a) If deposits reduced by 20 then bank can use cash of 10 and Reserves of 10 for reduction

Revised Balance sheet is as follows

Liabilities	Amount	Assets	Amount
Common Stock	20	Loans	200
Deposits	220	Treasury Bonds	20
		Reserves at FED	20
Total	240		240

Reseves at fed at below 10% requirement(22) but actual is 20 there fore bank is not in compliance with its reserve requirement.

b) Option-1 For compliance with reserve requirements

By selling Treasury Bonds of 2 then revised balance sheet

Liabilities	Amount	Assets	Amount
Common Stock	20	Loans	200
Deposits	220	Treasury Bonds	18
		Reserves at FED	22
Total	240		240

Option 2) By receiving Loan proceeds of 2

Liabilities	Amount	Assets	Amount
Common Stock	20	Loans	198
Deposits	220	Treasury Bonds	20
		Reserves at FED	22
Total	240		240