Question
In: Finance
You decide to fund a $5 million residential mortgage in 2018 by allocating capital and by...
You decide to fund a $5 million residential mortgage in 2018 by allocating capital and by issuing demand deposits. The mortgage represents a loan-to-value of 70 percent. The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium of 23 basis points. What is the minimum capital requirement on the mortgage in order for the institution to be adequately capitalized? Show work and briefly discuss the approach for finding what "adequately capitalizes" the mortgage. (Thank you)
Solutions
Expert Solution
| Loan to value ratio given as 70% |
| Mortgage loan = $ 5000000 |
| So, 100% value= 5000000/70%*100%= |
| 7142857 |
| "adequately capitalizes" means that the deposits or asset-backings are maintained to such a monetary level that meets the loan-to-value benchmark of 70% ---also taking into consideration the reserve requirement & the deposit insurance % , that is stipulated by the bank, that is required under the scheme , as per bank's norms. |
| That said, |
| From the above workings, the value of the assets should be $ 7142857 --to be eligible for a mortgage of $ 5000000 |
| But the capital requirements for the bank to release this much amount( $ 7142857) maintained in demand deposits, is after meeting the reserve requirement of 10% & deposit insurance premium of 23 basis points, or 0.23% |
| so, this amount becomes (1-(10%+0.23%)) of the deposits maintained.ie. |
| So, the minimum capital requirement on the mortgage in order for the institution to be adequately capitalized= |
| 7142857/(1-10.23%)= |
| 7956842 |
| Demand deposits | 7956842 |
| 10% reserve (unavailable)(DD*10%) | 795684 |
| 0.23% Dep.Ins.(DD*0.23%) | 18301 |
| DD available | 7142857 |
| 70% *above | 5000000 |
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