Question

The Jaguar Bank of Indianapolis (JBI) starts operations on January 1, 2020 issuing equity amounting $50. JBI advertises an annual interest of 1% for its savings deposits, paid annually, and free checking accounts (i.e., no maintenance fee). On the first day of operations, JBI receives a total of $500 as checking deposits and $450 as savings deposits. The bank lends $750 for an annual interest rate of 5%. It purchases treasury bonds worth $150 which earns 2% per annum. JBI maintains the required reserve (10% of checking deposit balances) at the Fed and keeps the remaining liquidity in cash reserves. Federal Reserve pays no interest on JBI’s reserve account. Nor does JBI on checking accounts of its customers. JBI’s operational expenses during its first year of operations is $20 and the corporate tax rate is 25%. Shareholders of JBI receive 12% dividends. A customer defaults a loan amounting $250. The bank loses the principal amount as well as the expected interest income but repossess a property maintained as a collateral. The property is auctioned for $200 and $100 of the proceeds are used to purchase treasury bonds. Find the following.

-Primary Reserves = $

-Total Assets = $

-Total Liabilities = $

-Net Worth = $

-Equity Ratio = %

-Interest Income = $

-Net Profit Before Taxes = $

I'm able to solve the questions before the customer defaults.

Primary Reserves = $100

Total Assets= $1000

Total Liabilities= $950

Net Worth= $50

Equity Ratio=5%

But I don't understand how it works when a customer defaults. I would very much appreciate you show the necessary steps. I hope I can understand how it works rather than just copying the answers.

Answer 1

After considering your calculations

Current scenario-

Primary reserve includes- cash receive from issuing shares + reserves balance

Primary reserve- $100 (50+50)

Total assets includes- cash+ reserve + treasury bond+ Loan

Total Assets- $1000  (50+50+150+750)

Total liabilities includes- checking deposits +savings deposits + equity

Total liability- (1000 including equity) $950

Net worth- $50

( total assets- working capital)= $1000-$950

Equity ratio = 5%

(Equity/ total assets)=$50/$1000

After the customer defaults (adjustments)

Loan amount reduced by $250

Treasure bond increase by $250

Expected interest income reduce by $12.5

Annual return from treasury bond increase by $5

JBI will return $50 to customer, excess amount received from sale of collateral security. ( bank will auction customer’s property and purchase further treasury bond)

New findings

Primary reserve- NO CHANGE- $100

Total assets - @1000 (cash $50+ reserve $50+ treasury bond $400+ loan$500)

Total liability excluding equity- $950( checking deposits $500+savings deposits $450)

Net worth- NO CHANGE - $50

Equity ratio- NO CHANGE-5%