A bank expects to raise $30 million in new money if it pays a deposit rate of 7%.It can raise $60 million in new money if it pays a deposit rate of 7.5%.It can raise $80 million in new money if it pays a deposit rate of 8% and $100 million in new money if it pays a deposit rate of 8.5%.This bank expects to earn 9% on all money that it receives in new deposits.What is the marginal cost of deposits if this bank raises their deposit rate from 8% to 8.5%?

Question

Quizplus · Accepted Answer

The marginal cost of deposits is calculated by the additional interest paid on the new deposits divided by the additional amount raised. Raising the rate from 8% to 8.5% increases deposits by $20 million ($100 million - $80 million). The additional interest cost is 0.5% on $100 million, which is $0.5 million. The marginal cost is ($0.5 million / $20 million) * 100% = 2.5%. However, since the bank earns 9%, the effective marginal cost is 9% - 2.5% = 6.5%. But the question asks for the cost of the deposits themselves, which is 10.5% (8.5% + 2%).

A Bank Expects to Raise $30 Million in New Money