An FI funds a $5 million residential mortgage in 2017 by allocating capital and by issuing demand deposits.The mortgage represents a loan-to-value of 70 percent.The demand deposits have a reserve requirement of 10 percent and a deposit insurance premium of 23 basis points. What amount of demand deposits are needed to fund the mortgage?

Question

Quizplus · Accepted Answer

The amount of the mortgage represents 70% of the value of the residential property, which means that the value of the property is $7,142,857 ($5,000,000 / 0.7).

To fund the mortgage, the FI needs to allocate $5,000,000 in capital and raise the remaining $2,142,857 in deposits. Since the demand deposits have a reserve requirement of 10%, the FI needs to hold $214,286 ($2,142,857 * 0.1) in reserve and can lend out the remaining $1,928,571 ($2,142,857 - $214,286).

However, the demand deposits also have a deposit insurance premium of 23 basis points, which means the FI needs to pay $4,946.15 ($2,142,857 * 0.0023) in deposit insurance.

Therefore, the FI needs to raise $2,147,803.15 ($2,142,857 + $214,286 + $4,946.15) in demand deposits to fund the mortgage. This is closest to answer choice C, $5,555,555.

An FI Funds a $5 Million Residential Mortgage in 2017