Question
In: Finance
Banks are able to convert short-term deposits into long-term loans. This process is called: A.Liquidity denomination...
Banks are able to convert short-term deposits into long-term loans. This process is called:
A.Liquidity denomination B.Adverse maturity transition C.Asset transformation D.Moral hazard mitigation
Solutions
Expert Solution
ANSWER: ( Option C ) Asset transformation
Asset transformation by bank is turning liabilities
(Deposits) into assets (Loan). More specifically, asset
transformation is the process of transforming bank liabilities
(deposits) into bank assets (loans).
For Example: Bank accept deposit from individuals. The term of
deposits can be different. Bank pool their entire investable
deposit and make small pieces which will be offered to the
borrower. Every pieces will consists of different amount of money,
condition and time to repay.
Here deposits are subject to withdrawal by customers (depositors) at any point in time or as stipulated in the deposit contract/agreement. Loans are bank assets because they represent money that the bank lends and expect to receive back in the form of principal and interest payments. As such, banks undertake asset transformation by lending long and borrowing short, with the interest rate differential being its transformation revenues. Typically, banks and other financial institutions perform asset transformation by offering their customers a variety of financial products on both sides of the balance sheet such as deposits, investment and loan products, etc.
other options are not correct because
(a)Liquidity denomination refers to the units classification for the stated or face value of financial instruments such as currency notes or coins, as well as for securities, bonds, and other investments.
(b) Adverse maturity transition is the practice by financial institutions of borrowing money on shorter timeframe than they lend money out.
(d) Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. It arises when both the parties have incomplete information about each other.
jeff jeffy answered 1 year agoRelated Solutions
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