Consider the two banks and their balance sheets below. For each bank, calculate
ID: 1094772 • Letter: C
Question
Consider the two banks and their balance sheets below. For each bank, calculate its return on equity (ROE) and leverage ratio
a. Bank A has net profit after taxes of $1.8 million and the balance sheet below:
Bank A (in millions) Assets Liabilities
Reserves $5 Deposits $100
Loans $70 Borrowing $10
Securities $45 Bank Capital $10
b. Bank B has net profit after taxes of $0.9 million and the balance sheet below:
Bank B (in millions) Assets Liabilities
Reserves $7.5 Deposits $75.0
Loans $55.0 Borrowing $3.0
Securities $23.5 Bank Capital $8.0
Explanation / Answer
Solution Bank A
Bank A
(in millions)
Assets
Liabilities
Reserves
$ 5.00
Deposits
$ 100.00
Loans
$ 70.00
Borrowing
$ 10.00
Securities
$ 45.00
Bank Capital
$ 10.00
Total Assets
$ 120.00
Total Liabilities
$ 120.00
Net Profit
$ 1.80
Return on Asset = Net profit/Total Assets
1.50%
Return on equity = Net profit / Total equity
Total equity in this case is equal to bank capital which is money invested by shareholders in the bank.
Total equity = Bank Capital = $ 10
Return on equity = $1.8 / 10 = 18%
Leverage = Total debt / Total Equity
Total Debt = Deposits with bank + Borrowing
Total Debt $ 100 + $ 10 = $110
Total equity = Bank Capital = $ 10
Leverage = $110/$10 = 11
Solution Bank B
Bank B
(in millions)
Assets
Liabilities
Reserves
$ 7.50
Deposits
$ 75.00
Loans
$ 55.00
Borrowing
$ 3.00
Securities
$ 23.50
Bank Capital
$ 8.00
Total Assets
$ 86.00
Total Liabilities
$ 86.00
Net Profit
$ 0.90
Return on Asset = Net profit/Total Assets
1.05%
Return on equity = Net profit / Total equity
Total equity in this case is equal to bank capital which is money invested by shareholders in the bank.
Total equity = Bank Capital = $ 8
Return on equity = $0.9 / 8 = 11.25 %
Leverage = Total debt / Total Equity
Total Debt = Deposits with bank + Borrowing
Total Debt $ 75+ $ 3= $78
Total equity = Bank Capital = $ 8
Leverage = $ 78/$ 8 = 9.75
Bank A
(in millions)
Assets
Liabilities
Reserves
$ 5.00
Deposits
$ 100.00
Loans
$ 70.00
Borrowing
$ 10.00
Securities
$ 45.00
Bank Capital
$ 10.00
Total Assets
$ 120.00
Total Liabilities
$ 120.00
Net Profit
$ 1.80
Return on Asset = Net profit/Total Assets
1.50%
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