This is my weekly homework Problem: a) What is the Eurodollar creation from a de
ID: 2760157 • Letter: T
Question
This is my weekly homework Problem: a) What is the Eurodollar creation from a deposit of $2 million when the offshore banks maintain a 5 percent reserve? Assume that the 2 million is deposited in a London office of Barclays Bank, which makes a loan to British Holding, which uses the funds to pay for goods from British Auto ltd, which in turn places the proceeds in Citibank in London. Assume that Citibank uses its extra dollars to make a loan to Aviva Corporation, which uses the dollars back in the US. b) Recompute the change in Eurodollars in a, above, assuming instead that 10 percent reserve/deposit ratio is maintained. c Recompute the change in Eurodollars in a, above, with 5 percent reserve ratio, assuming that five banks are involved before leakage occurs. d) What do you think is more important in affecting the size of the Eurodollar multiplier - the size of reserve ratio or the time before a leakage occurs?
Explanation / Answer
a)Total deposit in London office of Barclays Bank=$ 2 million
Eurodollar created from loan to British Holding=(1-0.05)*$ 2 million which are used to pay for goods from British Auto ltd and ultimately deposited in Citibank in London.
Eurodollar created from loan to Aviva Corporation=(1-0.05)*(1-0.05)*$ 2 million
Therefore the total Eurodollar created=$ 2 million+(1-0.05)*$ 2 million+(1-0.05)*(1-0.05)*$ 2 million
the total Eurodollar created=$ 2 million+(.95)*$ 2 million+(.95)*(.95)*$ 2 million
the total Eurodollar created=$ 2 million+$1.90 million+$1.805 million
the total Eurodollar created=$ 5.705 million
b) the total Eurodollar created (with ratio=10%)=$ 2 million+(1-0.10)*$ 2 million+(1-0.10)*(1-0.10)*$ 2 million
the total Eurodollar created (with ratio=10%)=$ 2 million+(.9)*$ 2 million+(.9)*(.9)*$ 2 million
the total Eurodollar created (with ratio=10%)=$ 2 million+$1.8 million+$ 1.62 million
the total Eurodollar created (with ratio=10%)=$5.42 million
Therefore change in Eurodollars from a above=-$ 5.705 million+$5.42 million=-$ 0.205 million
c)If five banks are involved before leakage occurs,
the total Eurodollar created
=$ 2 million+(.95)*$ 2 million+(.95)^2*$ 2 million+(.95)^3*$ 2 million+(.95)^4*$ 2 million+(.95)^5*$ 2 million
=$ 2 million+$1.90 million+$1.805 million+$ 1.71475 million+$ 1.6290125 million+$ 1.547561875 million
=$10.596 million
change in Eurodollars from a=$10.596 million-$ 5.705 million
change in Eurodollars from a=$ 4.891 million
d)As is evident from the above figures the change in reserve ratio did not affected the Eurodollar multiplier that much it merely decreased from (5.705 /2=2.85) to 5.42 /2=2.71 whereas with the change in time before the leakage occurs the multiplier increases manifolds to 10.596/2=5.30 therefore the impact of the change in time is more than the impact of change in ratio therefore the time before a leakage occurs is more important in affecting the size of the Eurodollar multiplier.
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