Table 9-5
Bolton Bank: Partial Balance Sheet
(All figures in $ million)

-Refer to Table 9-5. If the required reserve ratio is 10% and the market interest rate is 8%, what is Bolton Bank's opportunity cost of holding the excess reserves it is currently holding?
A) $5.6 million
B) $3.2 million
C) $0.8 million
D) 0; Bolton Bank has no excess reserves.

Question

Table 9-5
Bolton Bank: Partial Balance Sheet
(All figures in $ million)
 
-Refer to Table 9-5. If the required reserve ratio is 10% and the market interest rate is 8%, what is Bolton Bank's opportunity cost of holding the excess reserves it is currently holding?
A) $5.6 million 
B) $3.2 million 
C) $0.8 million 
D) 0; Bolton Bank has no excess reserves.

Quizplus · Accepted Answer

To calculate the opportunity cost of holding excess reserves, we need to first calculate the amount of excess reserves. Excess reserves = actual reserves - required reserves. In this case, excess reserves = $127 - ($745 x 0.10) = $50.5 million.

The opportunity cost of holding these reserves is the income that could have been earned if they were instead lent out at the market interest rate. Therefore, the opportunity cost = excess reserves x market interest rate = $50.5 million x 0.08 = $4.04 million.

However, we need to subtract the interest earned on the required reserves that Bolton Bank is currently holding. Required reserves = $745 x 0.10 = $74.5 million. Interest earned on required reserves = $74.5 million x 0.08 = $5.96 million.

Therefore, the net opportunity cost = $4.04 million - $5.96 million = -$1.92 million. This means that holding excess reserves is actually earning Bolton Bank a profit of $1.92 million.

So the correct answer is A) $5.6 million.

Table 9-5 Bolton Bank: Partial Balance Sheet