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4. Aloha Bank starts with $200 in Bank Capital. It then accepts $800 in deposits. It keeps 12.5% of deposits as Reserves. It uses the rest of its assets to make bank loans. (12 marks) A. Show the Balance Sheet of Aloha Bank. (3 marks) B. What is Aloha Banks’s leverage ratio? (3 marks) C. Suppose that 10% of the borrowers from Aloha Bank default and these loans became worthless, show the Bank’s new balance sheet. (3 marks) D. By what percentage do the Bank’s total asset decline and by what percentage does the Bank’s capital decline? (3 marks)

Answer:

Aloha Bank Balance Sheet

The balance sheet of Aloha Bank starts with $200 in Bank Capital and after accepting $800 in deposits, the balance sheet would look like this:

Assets: $800
Liabilities: $800
Bank Capital: $200

Aloha Bank’s Leverage Ratio

Aloha Bank’s leverage ratio is calculated by dividing its total assets by its total liabilities. In this case, the leverage ratio is 1:1, or 100%.

Aloha Bank’s Balance Sheet After Default

If 10% of the borrowers from Aloha Bank default and these loans become worthless, the Bank’s new balance sheet would look like this:

Assets: $720
Liabilities: $800
Bank Capital: $120

Aloha Bank’s Change in Assets and Capital

After the 10% default, the Bank’s total assets decline by 10%, or $80, while the Bank’s capital decline by 40%, or $80.

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