ProBanker Exercise 3 This assignment will demonstrate the importance of calculating the total cost of borrowed funds (federal funds, CDs and deposits) and the net return of earning assets (loans and...

ProBanker Exercise 3

This assignment will demonstrate the importance of calculating the total cost of borrowed funds (federal funds, CDs and deposits) and the net return of earning assets (loans and bonds).

The total costs include all expenses associated with the procurement of the funds. In the case of retail savings, it will include interest expense, operating costs (originating and maintaining accounts), advertising expenses and FDIC premiums. In the case of demand deposits, only operating and advertising costs are relevant since demand deposits pay no interest. However, they are subject to reserve requirements and may earn fee income. Hence, total cost includes both direct and indirect costs.

Net return on loans is the net interest income earned on loans less operating costs (originating and maintaining loans), advertising if any, and expected defaults.

The goal of a bank is to maximize the difference between average net return of loans (plus government bonds) and the average cost of borrowed funds.

Please see sections 4.4 of your student manual (click on Help on top right) for description of the costs and sections 6.12 and 6.13 of your student manual for an example of this assignment.

Assignment 3:

1. 
   

   Create a personal Autosim.
   
   
   

   
   




1. 
   

   Click on Games.

   
   


2. 
   

   Click on New Autosim game.

   
   


3. 
   

   Select Assignments Regional Bank template in using template.
   
   Note: Make sure NOT to choose Sample Regional Bank template.

   
   


4. 
   

   Type a name for the new Autosim in New game’s name. Example “John Roger’s Assignment 3”

   
   


5. 
   

   Click on Create Game
   
   

   
   




2. 
   

   Input decisions to your new Autosim. There are five categories of decisions – Bank Treasury, Asset-other, Asset-loans, Liabilities-deposits, Bank-general.

   
   

Click on Autosim Games (on left, in blue) or Games on top (in red)

1. 
   

   Select your newly created Autosim.

   
   


2. 
   

   Click on Play bank.

   
   


3. 
   

   Input and update Decisions.

   
   


4. 
   

   Remember to click Save before you go to the next set of inputs.

   
   

3. 
   

   Bank Treasury – change the following:

   
   




1. 
   

   Federal Funds Purchased (not Sold)= $100,000.

   
   


2. 
   

   360 Days CDs to Issue= $50,000.

   
   


3. 
   

   The remaining boxes should all be zeroes.
   
   

   
   




4. 
   

   Asset-other – change the following:

   
   




1. 
   

   Planned required reserves= $25,000.

   
   


2. 
   

   New Bonds to Purchase= $15,000.

   
   


3. 
   

   New provision for loan losses = $500.

   
   

5. 
   

   Asset-loans – change the following: reduce all loan rates by 0.3%.

   
   




1. 
   

   Fixed-rate loans: Reduce loan rate to 9 and keep corporate standards as normal (0).

   
   


2. 
   

   Floating-rate loans: Reduce loan spread to 3.7 and keep corporate standards as normal (0).

   
   


3. 
   

   Installment Loans: Reduce loan rate to 10.7 and keep advertising at 150.

   
   


4. 
   

   Mortgage loans: Reduce loan rate to 8.7 and keep advertising at 80.

   
   

6. 
   

   Liabilities-deposits – change the following: Increase all deposit rates by 1%

   
   




1. 
   

   Corporate demand deposit: Keep as is (0,580,100).

   
   


2. 
   

   Retail demand deposit: Keep as is (0,410,100).

   
   


3. 
   

   Retail savings: Increase deposit rate to 6 and keep advertising as 140.

   
   


4. 
   

   Retail CDs: Increase CD rate to 7 and keep advertising at 290.

   
   


5. 
   

   Long-term retail deposits: Increase deposit rate to 8.5 and keep advertising at 60.

   
   

7. 
   

   Bank-general – change the following:

   
   

Keep as is (0, 0)

8. 
   

   Simulate next period (on left side of the screen). After a few seconds, you will notice a flicker and it should say End of Period 1. You are ready to review the results.

   
   

Estimate the Total Cost of Borrowed Funds

1. 
   

   Fill in worksheet 1 to estimate the total cost of borrowed funds using the output of quarter 1.

   
   

2. 
   

   Operating costs for all loans and deposits should be taken from “Other Non-Interest Operating Costs” in your income statement. Be careful to annualize all expenses. That is, the quarterly operating cost must be multiplied by four to annualize it before adding to or subtracting from the contract rate.

   
   

3. 
   

   The contract rate is the rate quoted by the bank for deposits including negotiable CDs and fed funds borrowed, expressed as an annual percentage rate (enter twelve percent as 12.00). See the full balance sheet for the rates.

   
   

4. 
   

   Federal Funds Purchased (FFP), Federal Funds Sold (FFS), and Negotiable CDs (NCD) are obtained from perfect capital markets. Hence, they only incur one-time cost.

   
   

1. 
   

   Only one operating cost is provided for federal funds. Divide operating costs of federal funds by the total of FFP and FFS. Multiply by 4 for annual rate.

   
   


2. 
   

   Only one operating cost is provided for negotiable NCDs. Divide operating costs by the NEW amount of negotiable CDs. For 1-quarter NCD, multiply by 4, for 1-quarter NCD multiply by 2 and 4-quarter NCD multiply by 1, to annualize.

   
   

5. 
   

   For the rest of the individual deposits (corporate and retail demand, retail savings, retail CDs and long-term deposits), divide operating cost by their respective deposits and multiply by 4.

   
   

6. 
   

   Advertising expenses.

   
   

1. 
   

   For demand and retail savings deposits without maturity, divide advertising expenses by outstanding quarterly balance and multiply by 4.

   
   


2. 
   

   For retail CDs, divide advertising expenses by NEW CDs (T+2) and multiply by 2 because it matures in two quarters.

   
   


3. 
   

   For long-term retail deposits, divide advertising expenses by NEW LTRDs (T+8) and divide by 2 because it matures in eight quarters.
   .

   
   




7. 
   

   Fee income is for demand deposits only. Divide fee income by quarterly balance and multiply by 4.

   
   

8. 
   

   FDIC premium: Divide FDIC premium by all deposits including negotiable CDs and multiply by 4.

   
   

9. 
   

   Reserve requirement (RR) is only applicable for demand deposits. Divide total cost by (1 – RR) to obtain total cost of each individual fund.

   
   

Estimate the Net Return on Assets (Loans and government bonds)

Fill in worksheet 2 to estimate the net returns on loans and government bonds using the output for quarter 1.

1. 
   

   The contract rate is the rate quoted by the bank for loans and government bonds, expressed as an annual percentage rate (enter twelve percent as 12.00). See the full balance sheet for the rates.

   
   

2. 
   

   Operating costs should all be multiplied by 4 for all loans except government bonds which should be divided by 2 because it incurs only a one-time fee.

   
   

3. 
   

   Advertising expenses. For installment loans, divide advertising expenses by NEW installment loans (T+4) and for mortgages divide advertising expenses by new mortgages (T+8) and divide by 2.

   
   

4. 
   

   There are several ways to estimate the expected default rate. For this assignment, use 75% of the nonperforming rate as the expected default rate, unless communicated otherwise by your instructor. Multiply default rate of fixed-rate loans by 4, floating-rate loans by 2, installment loans by 1 and divide mortgage loans by 2.