17-94 What will be the cost of using a strategy of reducing its asset base to meet the expected decline in deposits? Assume that the bank intends to keep $2 million in cash as a liquidity precaution.

Question

Quizplus · Accepted Answer

To calculate the cost of reducing its asset base, we need to find out the amount by which the asset base needs to be reduced. Assuming that the expected decline in deposits is $3 million, the bank would need to reduce its asset base by $3 million - $2 million (cash liquidity) = $1 million.

Assuming an average cost of funds of 4%, the cost of reducing its asset base by $1 million would be:
$1 million * 4% = $40,000

Therefore, the cost of using a strategy of reducing its asset base to meet the expected decline in deposits would be $30,000 (since the bank intends to keep $2 million in cash as a liquidity precaution).

17-94 What Will Be the Cost of Using a Strategy