Derby Bank has the following balance sheet. Assets ($ million) Liabilities and equity ($ million) Treasury notes 100 Deposits 200 Loans 250 Overnight purchased funds 150 Non-earning assets 50 Equity 50 Total assets 400 Total liabilities and equity 400 One of Derby Bank’s wholesale customers decides to make an immediate deposit withdrawal of $55 million, and the bank adopts an asset liquidity management approach by liquidating Treasury notes to fund this withdrawal request. Which of the following statements is CORRECT? Select one: a. After the transactions, the bank has 155m in Treasury notes, 255m in deposits, and 455m in total assets. b. After the transactions, the bank has 45m in Treasury notes, 145m in deposits, and 345m in total assets. c. After the transactions, the bank has 100m in Treasury notes, 145m in deposits, 205m in overnight purchased funds, and total assets remain unchanged. d. After the transactions, the bank has 45m in Treasury notes, 145m in deposits, and total assets remain unchanged.
Liquidity management is a critical aspect of any financial institution’s operations, ensuring that the institution maintains an appropriate balance between its assets and liabilities to meet customer demands and regulatory requirements. Derby Bank faces a liquidity challenge as one of its wholesale customers requests an immediate withdrawal of $55 million. To address this, the bank decides to liquidate its Treasury notes to fund the withdrawal. This essay analyzes the impact of this transaction on Derby Bank’s balance sheet and presents the correct option among the provided choices.
Derby Bank’s balance sheet consists of assets and liabilities & equity. The assets include Treasury notes, loans, and non-earning assets, while the liabilities & equity encompass deposits, overnight purchased funds, and equity. The total assets and total liabilities & equity are both valued at $400 million.
A wholesale customer of Derby Bank initiates a deposit withdrawal of $55 million. To cover this withdrawal, the bank decides to liquidate its Treasury notes. Let’s explore the provided options and deduce the correct outcome.
Options: a. After the transactions, the bank has $155 million in Treasury notes, $255 million in deposits, and $455 million in total assets. b. After the transactions, the bank has $45 million in Treasury notes, $145 million in deposits, and $345 million in total assets. c. After the transactions, the bank has $100 million in Treasury notes, $145 million in deposits, $205 million in overnight purchased funds, and total assets remain unchanged. d. After the transactions, the bank has $45 million in Treasury notes, $145 million in deposits, and total assets remain unchanged.
Correct Answer: The correct option is b: “After the transactions, the bank has $45 million in Treasury notes, $145 million in deposits, and $345 million in total assets.”
The immediate deposit withdrawal of $55 million necessitates the liquidation of assets to cover the withdrawal. Derby Bank chooses to liquidate Treasury notes worth $55 million to meet this demand. As a result:
Treasury notes decrease by $55 million (from $100 million to $45 million).
Deposits decrease by $55 million (from $200 million to $145 million).
Total assets decrease by $55 million (from $400 million to $345 million).
In managing liquidity challenges, Derby Bank opted to liquidate Treasury notes to fund an immediate deposit withdrawal of $55 million. The resulting impact on the balance sheet led to reduced Treasury notes and deposits, consequently affecting the total assets. This analysis underscores the importance of strategic liquidity management for financial institutions like Derby Bank to navigate customer demands effectively and maintain a balanced financial position.
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