If the Fed buys a $100,000 government security from a bank when the desired reserve ratio is 20 percent and the currency drain ratio is 5 percent,the bank can loan a maximum of
A)$75,000.
B)$80,000.
C)$100,000.
D)$95,000.
E)$85,000.

Question

Quizplus · Accepted Answer

The desired reserve ratio is 20 percent, which means the bank must hold 20 percent of the deposit as reserves and can lend the remaining 80 percent.
The currency drain ratio is 5 percent, which means that 5 percent of the deposits are held by the public as currency and not in the bank as reserves. Therefore, the actual reserve ratio of the bank is only 15 percent (20% desired reserve ratio minus 5% currency drain ratio).
When the Fed buys a $100,000 government security from the bank, the bank's reserves increase by $100,000. The bank must hold 15 percent of this as reserves, which is $15,000. Therefore, the bank can lend the remaining $85,000 ($100,000 - $15,000).
Therefore, the maximum amount the bank can loan is $80,000 ($85,000 rounded down to the nearest thousand), so the correct answer is B.

If the Fed Buys a $100,000 Government Security from a Bank