Week 3 Solution

Week 3: Assignment 3 (Solutions)
1. Using the one-period valuation model, assuming a year-end dividend of $0.11, an

expected sales price of $110, and a required rate of return of 10%, the current price of the
stock would be
A) $110.11.
B) $121.12.
C) $100.10.
D) $100.11
Solution: To calculate the current price of the stock using the one-period valuation model,
we can use the formula:
Current Price= Dividend + Expected Sales Price

1 + Required Rate of Return
Plugging in the values: You will get
C) $100.10
2. With a 10% reserve requirement ratio, a ₹100 deposit into SBI means that the maximum
amount SBI could lend is
A) ₹90.
B) ₹100.
C) ₹10.
D) ₹110.
Solution: Given a ₹100 deposit into SBI and a 10% reserve requirement ratio, the
maximum amount SBI could lend out is 90% of ₹100, which is ₹90.
3. A price of the stock will fall if there is

A) a decrease in perceived risk.
B) an increase in the required rate of return.
C) an increase in the future sales price.
D) current dividends are high.
Answer: B
Solution: As the required rate of return increases, the present value of future cash flows
(such as dividends) decreases, causing the stock's price to fall.
4. An expectation may fail to be rational if

A) relevant information was not available at the time the forecast is made.
B) relevant information is available but ignored at the time the forecast is made.
C) information changes after the forecast is made.
D) information was available to insiders only.
Answer: B
Solution: An expectation is considered rational when it is based on all available and
relevant information at the time the forecast is made. If relevant information is available
but ignored by the person making the forecast, their expectation may fail to be rational.
5. If a bank needs to raise the amount of capital relative to assets, a bank manager might
choose to
A) buy back bank stock.
B) pay higher dividends.
C) shrink the size of the bank.
D) sell securities the bank owns and put the funds into the reserve account
Answer: C
Solution: Shrinking the size of the bank through reducing the size of its loan portfolio or
selling off certain assets would lead to reduction of the assets on its balance sheet. This
raises the bank's capital-to-assets ratio, helping it to meet regulatory requirements or
improve its financial stability.
6. Bankersʹ concerns regarding the optimal mix of excess reserves, secondary reserves,
borrowings from the RBI, and borrowings from other banks to deal with deposit outflows
is an example of
A) liability management.
B) liquidity management.
C) managing interest rate risk.
D) managing credit risk.
Answer: B
Solution: Liquidity management involves making sure that a bank has sufficient liquid
assets and funding sources to meet its short-term financial obligations and unexpected
demands, such as deposit withdrawals.
7. When you deposit a 50 rupees bill in the SBI and 50 rupees in currency at ICICI,
A) assets of SBI decrease by 50 rupees and liabilities of ICICI increase by 50 rupees..
B) assets of SBI increase by 50 rupees and liabilities of ICICI increase by 50 rupees.
C) assets of SBI increase by 50 rupees and liabilities of ICICI decrease by 50 rupees.
D) assets of SBI decrease by 50 rupees and liabilities of ICICI decrease by 50 rupees.
Answer: B
Solution: When you deposit 50 rupees in currency at ICICI, their liabilities increase by 50
rupees (as they owe you 50 rupees in the form of a deposit).
8. Banks may borrow from or lend to another bank. A loan of excess reserves from one
bank to another bank is recorded as a(n) ________ for the borrowing bank and a(n)
________ for the lending bank.
A) asset; asset
B) asset; liability
C) liability; liability
D) liability; asset
Answer: D
Solution: When one bank lends excess reserves to another bank, it creates a liability for
the borrowing bank because it owes the lending bank the amount of the loaned reserves.
At the same time, it creates an asset for the lending bank because it now holds a claim on
the borrowing bank for the amount of the loan.
9. Bank capital is equal to ________ minus ________.

A) total assets; total liabilities
B) total liabilities; total assets
C) total assets; total reserves
D) total liabilities; total borrowings
Answer: A
Solution: Bank capital is the difference between a bank's total assets and its total
liabilities.
10. Because of the adverse selection problem,

A) good credit risks are more likely to seek loans causing lenders to make a
disproportionate amount of loans to good credit risks.
B) lenders may refuse loans to individuals with high net worth, because of their
greater proclivity to ʺskip town.ʺ
C) lenders are reluctant to make loans that are not secured by collateral.
D) lenders will write debt contracts that restrict certain activities of borrowers.
Answer: C
Solution: The adverse selection problem can lead to lenders being hesitant to make loans
without proper collateral because of the uncertainty about the borrower's
creditworthiness.

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Week 3: Assignment 3 (Solutions)

1. Using the one-period valuation model, assuming a year-end dividend of $0.11, an

Current Price= Dividend + Expected Sales Price

Plugging in the values: You will get

3. A price of the stock will fall if there is

4. An expectation may fail to be rational if

9. Bank capital is equal to minus .

10. Because of the adverse selection problem,

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