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Calculate the risk-adjusted asset base for a bank with: a. Cash of $20 million, 0% b. Gen. Obligation municipal security of $100 million, 20% c. Singe family home mortgages of $500 million, 50% d. Commercial loans of $300 million, 100%. 4a. If the bank has no off-balance sheet activity what is the bank=s minimum required level of Tier1 and Tier 2 capital? 4b. If the bank has Tier 1 capital of $25 million and Tier 2 capital of $15 million does the bank comply with its capital requirement. 4c. Also, explain how the addition of off-balance sheet activities might impact the capital requirement of the bank

Verified Answer :

This is what i found  Answer 1

Risk-Adjusted Asset Base

The calculation of the risk-adjusted asset base for a bank is as below-

Risk-adjusted asset = (Cash × 0%) + (municipal security × 20%) + (home mortgages × 50%) + (Commercial loans × 100%)

= (20 × 0%) + (100 × 20%) + (500 × 50%) + (300$ × 100%)

= 0 + 20 + 250 + 300

= $570 million

The outcome shows that the risk-adjusted or weighted asset based for the bank will be $570 million.

Tier1 and Tier 2 Capital:

If the bank has no off-balance sheet activity then minimum required level of Tier 1 and Tier 2 capital will be-

Tier 1 capital = Risk-weighted asset × 4%

= $570 × 4%

= $22.8 million

Tier 2 capital = Maximum of 1.25% of risk-weighted asset

= $570 × 1.25%

= $7.125 million

Total capital = $22.8 + $7.125 => $29.925 million

The outcomes indicate that the minimum required level of Tier1 and Tier
2 capital is $22.8 million and $7.125 million for the bank.

Bank Comply with Capital Requirements:

If the bank has Tier 1 capital of $25 million and Tier 2 capital of $15
million then it will comply with its capital requirements of $29.925
million. It is because in this situation, total capital of bank is $37
million that is higher than the above calculated capital of $29.925
million.

Impact of off-Balance Sheet Activities on Capital Requirements

The addition of off-balance sheet activities might increase the capital
requirement of the bank. It is because an off-balance sheet items is a
financial contract that can create credit loss for the company due to
credit risk. So, in case of adding off-balance sheet activities, a bank
will require more capital to cover credit loss. Along with this, it can
also increase the minimum ratio of capital to risk-weighted assets from
8% and in that situation; the bank will need more capital (Carmichael
& Graham, 2012).

Answer 2

Probability of Repayment and Risk Premium

A).

If the rate on a one-year treasury bill is 6% and in case of loan
default, no payments are expected on financial securities then the
probability of repayment and the risk premium on 1 year AA-rated loan
yielding 9 percent will be-

Probability of Repayment:

The following formula can be useful to determine probability of repayment.

P = (1 + I) / (1 + k)

Where,

I = 6%

k = 9%

Then, ...you have $2.19 left :D