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Assume the following balance sheet for a commercial bank: Assets Liabilities Reserves 50 Demand Deposits 500 Government Securities 100 Time Deposits 250 (CDs) Mortgages 400 Savings Deposits 170 Loans 450 Capital 80 The reserve requirement is 10% of demand deposits. Assets Liabilities Reserves 50 Demand Deposits 500 Government Securities 100 Time Deposits (CDs) 250 Mortgages 400 Savings Deposits 170 Loans 450 Capital 80 The reserve requirement is 10% of demand deposits. a. Suppose the value of the bank's assets decline by x percent. What is the maximum value of x that the bank can sustain and still remain solvent? b. Which liability category is usually the lowest cost of funding for banks? c. Which liability includes borrowing from money market mutual funds?

Answer :

a. The maximum value of x, the percentage decline in the bank's assets, that the bank can sustain and remain solvent depends on the capital adequacy ratio (CAR) requirement set by regulatory authorities.

If the CAR requirement is, for example, 8%, then the maximum value of x can be calculated as (1 - CAR) multiplied by the bank's total assets. In this case, with a capital of 80 and total assets of 1,270, the maximum value of x would be 109.7%.

b. Savings deposits are usually the lowest cost of funding for banks. These deposits tend to have lower interest rates compared to other liability categories because they are often held by individuals for the purpose of saving money, and they may have certain restrictions or withdrawal penalties.

c. Borrowing from money market mutual funds is typically included in the liability category of time deposits or certificates of deposit (CDs). Money market mutual funds invest in short-term debt securities, and banks may borrow from these funds to meet their short-term liquidity needs.

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