Professional Documents
Culture Documents
Part I
LIQUIDITY RISK
Liquidity Risk
Liquidity risk is a normal aspect of the everyday management of
transformation function.
A DI use a large amount of short-term liabilities to finance longterm assets.
deposit drain.
drains.
Run down cash assets.
Sell liquid assets.
the market.
The cost to the DI is that, apart from decreased asset size, it
must hold excess low-rate assets on the balance sheet and thus
forgo the returns that it could otherwise earn by investing these
funds in loans and other higher-income-earning assets.
The Federal Reserve sets minimum reserve requirements for the
cash reserve the DIs must hold. DIs tend to hold cash in excess
of the minimum requirement to meet liquidity drains.
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methods.
Example: An exercise of $5 million loan commitment.
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Part II
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deposits.
For example, during the financial crisis of 2008-2009, banks
stopped lending to each other at anything but high overnight rates.
The commercial paper market also froze.
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Liquidity Index
This index measures the potential losses an FI could suffer from
=1
where is the weight of asset i in total asset, is asset is firesale price and * is asset is fair market price.
0 < 1 and the higher the the more liquid the DIs portfolio of
assets.
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Financing Gap
Although demand deposits can be withdrawn anytime, most
The larger a DIs financing gap and liquid asset holdings, the
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Part III
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Part IV
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Bank Runs
Bank run is a sudden and unexpected increase in deposit
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Deposit Insurance
FDIC insurance covers all deposit accounts. The standard
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Discount Window
Discount window loans are meant to provide temporary liquidity
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Discount Window
Three lending programs are offered through the Feds discount
window.
Primary credit is available to generally sound DIs on a very shortterm basis, typically, overnight, at a rate above the Federal Funds
rate. Primary credit may be used for any purposes.
Secondary credit is available to DIs that are not eligible for primary
credit. It is extended on a very short-term basis at a rate that is
above the primary credit rate. Its use should be consistent with a
timely return to a reliance on market sources of funding or the orderly
resolution of a troubles institution.
The Feds Seasonal credit program is designed to assist small DIs in
managing significant seasonal swings in their loans and deposits.
Eligible institutions are usually located in agricultural
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$1,000,000
10,000
= $100
During the day, suppose the asset value falls to $500,000 and
500,000
10,000
= $50
The shares are redeemed at $50 per share. After the redemption,
the mutual fund has 5,000 shares outstanding and $250,000
assets under management.
Key point: All investments and redemptions during the day are
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Part V
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Passbook Savings
These accounts are non-checkable and usually involve physical
presence at the DI to withdrawal. The DI has the legal power to
delay payment or withdrawal requests for as long as a month.
The principal costs to the DI are the explicit interest payments on
these accounts.
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MMDAs
In the U.S., MMDAs are checkable but subject to restrictions on
the number of checks written on each account per month, the
number of preauthorized automatic transfers per month, and the
minimum denomination of the amount of each check. In addition,
the MMDAs impose minimum balance requirements on
depositors. The Fed does not require the DIs to hold reserves
against MMDAs. Accordingly, DIs generally pay a higher rates on
MMDAs than on NOW accounts.
The explicit interest paid to depositors is the major cost of
MMDAs. The DI managers can use the spread on MMMF-MMDA
accounts to influence the net withdrawal rate on MMDAs.
The rate that MMMFs pay on their shares directly reflects the rates
earned on the underlying money market assets. However, the rates on
MMDAs are not based directly on any underlying portfolio of money
market assets.
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Wholesale CDs
A depositor can sell a relatively liquid wholesale CD without
causing adverse withdrawal risk exposure for the DI. The only
withdrawal risk is that these CDs are not rolled over and
reinvested by the holder of the deposit claim on maturity.
The rates paid on these instruments are competitive with other
wholesale money market rates, especially those on commercial
papers and T-bills. In addition, required yield on CDs reflect
investors perception of the depth of the secondary market for
CDs.
Only the first $250,000 (per investor, per institution) invested in
these CDs is covered by deposit insurance.
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Federal Funds
Besides funding their assets by issuing deposits, DIs also can
funds market. This refers to the interbank market for excess cash
reserves where DIs with excess reserves can lend their surplus
balances to DIs in need of those balances to earn interest.
Federal funds are short-term uncollateralized loans made by one
DI to another; more than 90 percent of such transactions have
maturities of one day.
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Federal Funds
The cost of fed funds for the purchasing institution is the federal
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Repurchase Agreement
A major liability management difference between fed funds and
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1
360
0.03 = $10,000,833
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Bankers Acceptance
A bankers acceptance (BA) is created when a time draft drawn
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Commercial Papers
Commercial paper is an unsecured short-term promissory note
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in itself.
Even though withdrawal risk may be reduced if lenders in the
market for borrowed funds have confidence in the borrowing DI,
perceptions that the DI is risky can lead to sudden nonrenewals of
fed funds and RP loans and the nonrollover of wholesale CDs and
other purchased funds as they mature.
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Supplemental Materials
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within the Federal Reserve, establishes the target for the federal
funds rate and oversee the open market operations (i.e., the
Fed's buying and selling of United States Treasury securities) to
keep the federal funds rate within a narrow band of the target.
The FOMC holds eight regularly scheduled meetings per year.
Open market operations is a main tool of U.S. monetary policy.
Changes in the federal funds rate trigger a chain of events that
affect other short-term interest rates, foreign exchange rates,
long-term interest rates, the amount of money and credit, and,
ultimately, a range of economic variables, including employment,
output, and prices of goods and services.
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is the cash rate the rate at which banks borrow and lend to
each other on an overnight, unsecured basis.
To meet the Board's target, the Reserve Bank operates in
financial markets to maintain an appropriate level of exchange
settlement (ES) balances. ES balances are liabilities of the Bank
and are used by financial institutions to settle their payment
obligations with each other and with the Bank.
The Bank pays interest on ES balances at a rate 25 basis points
below the Board's cash rate target. ES account holders are not
permitted to overdraw their accounts, although the Bank is willing
to advance overnight funds, against appropriate securities, to
account holders at an interest rate 25 basis points above the
cash rate target.
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