An FI operating in the United States funds a US$5 million residential mortgage in 2014 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 to FDIC of 23 basis points. What amount of demand deposits are needed to fund the mortgage?

Question

Quizplus · Accepted Answer

To fund the mortgage of US$5 million with a loan-to-value of 70%, we need to allocate 30% of the amount, i.e., US$1.5 million. 
To issue demand deposits of US$1.5 million, we need to calculate the required reserves as follows:
Required reserves = Deposit amount * Reserve requirement
Required reserves = US$1.5 million * 10%
Required reserves = US$150,000

The FI needs to pay a deposit insurance premium of 23 basis points on the demand deposits. Therefore, the total cost of funding the mortgage through demand deposits is:
Total cost = Deposit amount + Deposit insurance premium
Total cost = US$1,500,000 + (0.23% * US$1,500,000)
Total cost = US$1,500,000 + US$3,450
Total cost = US$1,503,450

Thus, the amount of demand deposits needed to fund the mortgage is US$1,503,450, which is closest to option C, US$5,555,555.

An FI Operating in the United States Funds a US$5