Financial Instruments, Institutions and Markets



Financial Instruments, Institutions and Markets

Question#1

Banking operations

Banking operations include its legal transactions that take place on a daily basis. The bank operates in order to provide loans, mortgages and investments. The bank also offers deposits to its customers in order to have current or saving accounts .All these operations depend on the size of the bank and its focus of work.

These operations mainly start with customer identification in terms of its requirements. The customer can have saving or current accounts in the bank. For this bank has to provide assurance to the customers. Banking activities revolve around borrowing and lending. They borrow money by holding them as term or fixed deposits. They then lend this borrowed amount either to an individual or financial institution. Different types of payment services are provided by a bank which is considered a reliable source. (www.apcob.org, 2013)

Why banks can operate with high leverage?

According to the Modigliani Miller theorem that states, the higher the equity used the greater the return on equity falls and here safety of debt rises. This is the reason that leads to the decline in the rate of return of both the sources. It happens in a way that the weighted average cost of capital remains unchanged. (Modigliani and Miller 1958).

There are reasons why this theorem of Modigliani Miller is unlikely to be implemented, but this would be a mistake to just think that the decreasing volatility of returns on the equity of banks coming from small bank leverage has no effect on its cost at all.

High leverage is significant for banks. It is a unique feature of the bank's capital structure. Bank realizes optimal returns through it. Bank's liquidity is priced at a premium amount because of the demand for capital. Banks itself chooses high leverage deposits despite of the fact that there is no agency cost, deposit insurance and tax motives to borrow.

If any bank encounters regulatory limits on leverage then it would have disadvantage. Liquidity will transfer from such banks. When liquidity is based on premium, banks have an advantage of choosing safe asset structures to support their capital structures which will maximize the production of safe financial claims. There is almost no chance for a bank to default as the MM capital market conditions bank to have uniquely safe assets and perfect structures for liability. (Unknown, 2013)

Leverage Ratios

The leverage ratio of DBS is 9.42 (Dbs.com, 2010)

Financial Leverage of Bank of America is 15.37 (Financials.morningstar.com, 2000)

Difference

This is showing that Bank of America is maintaining greater leverage as compared to DBS. Banks with greater leverage are always at a competitive end because of their unique capital structure. Bank of America has a competitive edge over DBS. High leverage is significant for banks. It is a unique feature of the bank's capital structure. Bank realizes optimal returns through it. Bank's liquidity is priced at a premium amount because of the demand for capital.

If there is a greater increment in the bank's capital there is always ...