Question

A DI has assets of $12 million consisting of $5 million in cash and $7 million in loans. It has core deposits of $6 million. It also has $3 million in subordinated debt and $3 million in equity. Increases in interest rates are expected to result in a net drain of $1 million in core deposits over the year.

a-1. The average cost of deposits is 3 percent and the average yield on loans is 6 percent. The DI decides to reduce its loan portfolio to offset this expected decline in deposits. What is the cost to the firm from this strategy after the drain? (Enter your answer in dollars not in millions.)
a-2. What will be the total asset size of the firm after the drain? (Enter your answer in millions.)
b-1. If the cost of issuing new short-term debt is 4.5 percent, what is the cost of offsetting the expected drain if the DI increases its liabilities? (Enter your answer in dollars not in millions.)
b-2. What will be the total asset size of the DI from this strategy after the drain?

Answer 1

Given,

Core deposits = $ 6 million

Subordinated debt = $ 3 million

Equity = $ 3 million

Net drain in core deposits = $ 1000000

Solution :-

a-) Cost of the dacuin Average yieldl or loans Average lost ot deposits 1 On In Core de posits Co.c6 - (a.ob O.03) X 1l 000000 a.03) #1000000 30000 1 la-2) Core de posits het daain in After clecline to would depos its COde 41 million) $5 million 6 million

So Total asset size of the Arm Declined lore cdeposits Subordinated debt +equity + E$S millic t43 million +$3 milli on 11 million lb-1) ot the clxcuin Cost ost ot issuing hew -Average Cost of deposits/ het drain m Core de posits Short term debt 0.045-0.03) x 1000000 (0.015) 1000000 15000 S3

above Strateg9y pfter Using the total asset size of DI woulel the out to 1R million Because Come Core p As there is decrease n liadilities its incrcases D I deposits