1. Focus of GAP and Duration Gap and which is more inclusive.2. Major types of funding for a commercial bank. Chapter 103. Meeting Legal Reserve Requirements. Chapter 11I already uploaded the textbook “Bank Management”, please discuss these three questions according to the textbook.
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Bank Management
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Bank Management
8e
Timothy W. Koch
University of South Carolina
S. Scott MacDonald
Southern Methodist University
Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States
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Bank Management, Eighth Edition
© 2015, 2010 Cengage Learning
Timothy W. Koch and S. Scott
MacDonald
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Printed in the U nited States of America
Print N umber: 01
Print Year: 2014
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Dedication
To Susan, Michala and Andy for all the joys of family.
Timothy W. Koch
To my family, Becky, Cassy, Erin, Jeff and Weston for their never-ending
support and encouragement.
S. Scott MacDonald
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Contents
Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii
About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xx
Chapter 1
Banking and the Financial Services Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Global Financial Crisis of 2007–2009 2
How Do Banks Differ? 7
Organizational Structure 15
Financial Services Business Models 18
Too Big to Fail Banks 23
Different Channels for Delivering Banking Services
Summary 26
Questions 27
Activities 28
References 28
25
Chapter 2
Government Policies and Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Historical Bank Regulation 32
Goals and Functions of Depository Institution Regulation 32
Ensure Safety and Soundness and Provide an Efficient and Competitive System
New Charters 35
Shortcomings of Restrictive Bank Regulation 44
Maintaining Monetary Stability and the Integrity of the Payments System 44
Efficient and Competitive Financial System 50
Too Big To Fail 60
Summary 63
Questions 64
Activities 65
References 65
34
Chapter 3
Analyzing Bank Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Commercial Bank Financial Statements 69
The Relationship between the Balance Sheet and Income Statement
The Return on Equity Model 91
Managing Risk and Returns 100
Financial Statement Manipulation 131
Summary 134
Questions 134
Problems 136
References 137
Appendix 139
90
vi i
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viii
Contents
Chapter 4
Managing Noninterest Income and Noninterest Expense . . . . . . . . . . . . . . . . . . . . . . . 159
Noninterest Income 164
Noninterest Expense 169
Which Lines of Business and Customers Are Profitable?
Summary 184
Questions 185
Activity 186
References 186
174
Chapter 5
The Performance of Nontraditional Banking Companies . . . . . . . . . . . . . . . . . . . . . . 189
The Disappearance of Large Investment Banks 191
Goldman Sachs Group, Inc., and Goldman Sachs Bank USA 193
The Financial Performance of Mutual of Omaha Bank 202
The Financial Performance of BMW Financial Services and BMW Bank of North America
Summary 209
Questions 210
Activities 210
References 211
205
Chapter 6
Pricing Fixed-Income Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 213
The Mathematics of Interest Rates 214
Simple versus Compound Interest 217
The Relationship between Interest Rates and Option-Free Bond Prices 219
Duration and Price Volatility 224
Recent Innovations in the Valuation of Fixed-Income Securities and Total Return Analysis
Money Market Yields 233
Summary 236
Questions 237
Activities 239
References 240
229
Chapter 7
Managing Interest Rate Risk: GAP and Earnings Sensitivity . . . . . . . . . . . . . . . . . . . 241
Measuring Interest Rate Risk with GAP 245
Earnings Sensitivity Analysis 263
Income Statement GAP 272
Managing the GAP and Earnings Sensitivity Risk
Summary 275
Questions 276
Activities 279
References 281
274
Chapter 8
Managing Interest Rate Risk: Economic Value of Equity . . . . . . . . . . . . . . . . . . . . . . . 283
Measuring Interest Rate Risk with Duration Gap 285
Economic Value of Equity Sensitivity Analysis 295
Earnings Sensitivity Analysis versus EVE Sensitivity Analysis: Which Model Is Better?
298
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Contents ix
A Critique of Strategies for Managing Earnings and Economic Value of Equity Sensitivity
Yield Curve Strategies 303
Summary 305
Questions 305
Activity 307
References 307
301
Chapter 9
Using Derivatives to Manage Interest Rate Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309
Characteristics of Financial Futures 310
Speculation versus Hedging 319
Microhedging Applications 327
Macrohedging Applications 330
Using Forward Rate Agreements to Manage Rate Risk
Basic Interest Rate Swaps as a Risk Management Tool
Interest Rate Caps and Floors 342
Summary 357
Questions 357
Activities 361
References 364
333
335
Chapter 10
Funding the Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 365
The Relationship between Liquidity Requirements, Cash, and Funding Sources
Characteristics of Retail-Type Deposits 370
Characteristics of Large Wholesale Liabilities 379
Electronic Money 390
Check 21 392
Measuring the Cost of Funds 395
The Average Historical Cost of Funds 396
Funding Sources and Banking Risks 403
Summary 405
Questions 406
Problems 408
References 409
366
Chapter 11
Managing Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 413
Meeting Liquidity Needs 414
Reserve Balances at the Federal Reserve Bank 418
Required Reserves and Monetary Policy 418
Meeting Legal Reserve Requirements 421
Liquidity Planning 427
Traditional Aggregate Measures of Liquidity Risk 433
Basel III and the Liquidity Coverage Ratio 436
Longer-Term Liquidity Planning 437
Contingency Funding Plans 442
Summary 445
Questions 445
Activity 447
References 447
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x
Contents
Chapter 12
The Effective Use of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 449
Why Worry about Bank Capital? 450
Risk-Based Capital Standards 451
What Constitutes Bank Capital? 458
Tangible Common Equity 461
What Is the Function of Bank Capital? 463
How Much Capital Is Adequate? 466
The Effect of Capital Requirements on Bank Operating Policies
Characteristics of External Capital Sources 471
Contingent Convertible Capital 472
Capital Planning 474
Depository Institution Capital Standards 478
Changes to Capital Standards Under Basel III 478
Summary 481
Questions 481
Problems 483
References 484
467
Chapter 13
Overview of Credit Policy and Loan Characteristics . . . . . . . . . . . . . . . . . . . . . . . . . . . 485
Recent Trends in Loan Growth and Quality 486
Measuring Aggregate Asset Quality 495
The Credit Process 497
Characteristics of Different Types of Loans 507
Summary 522
Questions 522
Problems 523
Activity 524
References 524
Chapter 14
Evaluating Commercial Loan Requests and Managing Credit Risk . . . . . . . . . . . . . . 527
Fundamental Credit Issues 529
Evaluating Credit Requests: A Four-Part Process 534
Credit Analysis Application: Wade’s Office Furniture 555
Managing Risk with Loan Sales and Credit Derivatives 570
Summary 574
Questions 574
Problems 577
References 580
Appendix I 582
Appendix II 584
Appendix III
585
Chapter 15
Evaluating Consumer Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 587
Types of Consumer Loans 589
Consumer Credit Regulations 599
Credit Analysis 607
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Contents x i
Recent Risk and Return Characteristics of Consumer Loans
Summary 620
Questions 620
Problems 622
Activities 622
References 623
617
Chapter 16
Managing the Investment Portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625
Dealer Operations and the Securities Trading Account 627
Dodd–Frank Act Provisions Affecting Bank Investments 628
Objectives of the Investment Portfolio 629
Composition of the Investment Portfolio 633
Characteristics of Taxable Securities 634
Prepayment Risk on Mortgage-Backed Securities 645
Characteristics of Municipal Securities 653
Establishing Investment Policy Guidelines 658
What Are Suitable Investment Securities? 659
Active Investment Strategies 660
The Impact of Interest Rates on the Value of Securities with Embedded Options
Comparative Yields on Taxable versus Tax-Exempt Securities 677
The Impact of the Tax Reform Act of 1986 681
Strategies Underlying Security Swaps 683
Summary 686
Questions 687
Problems 689
Activity 690
References 691
667
Chapter 17
Global Banking Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 693
U.S. Depository Institutions in the World Market 693
Impact of the Credit Crisis of 2007–2008 697
The European Community 703
Universal Banking Model 704
Organizational Structure of U.S. Banks with Foreign Operations
International Financial Markets 708
International Lending 711
Foreign Exchange Activities 717
Summary 721
Questions 722
References 723
706
Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 725
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 753
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Preface
The world of banking has changed dramatically since 2007 when many large financial
institutions around the world failed and were bailed out by their central governments.
The United States and global economies subsequently fell into recession. Millions of
Americans lost their jobs, and household net worth plummeted with the decline in housing and the value of investments. The ongoing recovery continues to be slow and painful
for many. Not surprisingly, the reputations of many banks and the banking industry in
general have suffered. Yet, if done correctly, banking is a critical driver of economic
activity and a noble profession. It involves the processing of payments, accepting deposits and making loans, safekeeping documents and valuable items, providing guarantees
and performance bonds, offering cash management, brokerage and insurance services,
and providing securities underwriting and market-making services.
So, what caused a breakdown in the financial services industry leading to the recent
financial crisis? In 2011, the National Commission on the Causes of the Financial and
Economic Crisis in the United States published a report that said both senior management at large financial institutions and key government officials ignored warning signals
and inadequately managed risks; and that the crisis was avoidable.1 It attributed the crisis
to: (1) risky lending via subprime mortgages; (2) trading activities at large institutions;
(3) unregulated derivatives markets; and (4) problems with lending via repurchase agreements, among other factors. In response, the U.S. Congress passed the Dodd–Frank Wall
Street Reform and Consumer Protection Act in June 2010 (commonly labeled the Dodd–
Frank Act), which has produced and continues to produce numerous changes in the regulation of financial firms. The global crisis has similarly brought about changes in regulations at financial firms in other industrialized countries.
One of the most unusual results of the crisis and subseq …
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