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(Solution) - Consider the following balance sheets for two hypothetical financial institutions

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Consider the following balance sheets for two hypothetical financial institutions, bank B and bank C:
Bank B?s Balance Sheet

Bank C?s Balance Sheet
(a) Fill in the missing entries in the balance sheets (denoted ???).
(b) What is the leverage ratio in each bank?
(c) Suppose housing prices fall sharply and the mortgage-backed securities held by bank C fall in value to only $500. What happens to bank C?s net worth?
(d) The shortfall in bank C?s equity means that it cannot repay the loan it received from bank B. Assume bank C pays back as much as it can, while still making good on its deposits. What happens to the net worth of bank B?
(e) Discuss briefly how this is related to systemic risk.


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This question was answered on: Jul 11, 2017

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