The average interest earned on the loans is 6 percent and the average cost of deposits is 5 percent. Rising interest rates are expected to reduce the deposits by $3 million. Borrowing more debt will cost the bank 5.5 percent in the short term.
-What will be the size of the bank if a purchased liquidity management strategy is adopted?
A)$9 million.
B)$11 million.
C)$12 million.
D)$14 million.
E)$15 million.

Question

The average interest earned on the loans is 6 percent and the average cost of deposits is 5 percent. Rising interest rates are expected to reduce the deposits by $3 million. Borrowing more debt will cost the bank 5.5 percent in the short term.
-What will be the size of the bank if a purchased liquidity management strategy is adopted?
A)$9 million. 
B)$11 million. 
C)$12 million. 
D)$14 million. 
E)$15 million.

Quizplus · Accepted Answer

To determine the size of the bank with a purchased liquidity management strategy, we need to consider the impact of the expected reduction in deposits and the cost of borrowing more debt.

If deposits decrease by $3 million, the bank's total size will be reduced by that amount as well since deposits are a liability for the bank.

To maintain the same level of lending activity, the bank may need to borrow more debt, but this will come with a cost of 5.5 percent in the short term.

A purchased liquidity management strategy can help the bank mitigate these risks and maintain its size and lending activity. Therefore, the best choice would be C) $12 million.

The Average Interest Earned on the Loans Is 6 Percent