Derby Bank has the following balance sheet. [table]
Assets ($ million) | Liabilities and equity ($ million) Treasury notes | 100 | Deposits | 175 Loans | 200 | Overnight purchased funds | 120 Non-earning assets | 50 | Equity | 55 Total assets | 350 | Total liabilities and equity | 350
[/table] Derby Bank’s largest customer decides to exercise a $25 million loan commitment, and the bank adopts an asset liquidity management approach by liquidating Treasury notes to fund this loan commitment. Which of the following statements is CORRECT?[Fill in the blank]

Question

BlackTom AI · Accepted Answer

Start by understanding Derby Bank's initial balance sheet setup: Treasuries = 100, Loans = 200, Total assets = 350; Deposits = 175, Overnight purchased funds = 120, Non-earning assets = 50, Equity = 55, Total liabilities and equity = 350. The bank adopts an asset liquidity management approach, liquidating Treasury notes to fund a $25 million loan commitment. This action reduces Treasuries and increases Loans by the same amount, with no change to total assets or liabilities. Now evaluate each option in light of this.

Option a: '125m in Treasury notes, 175m in loans, and total assets remain unchanged.' Increasing Treasuries to 125 and reducing loans to 175 implies moving funds from loans to Treasuries, which contradicts funding a loan commitment by liquidating Treasuries. This would also keep total assets unchanged but misstates the directional change in the components. Therefore, this is incorrect.

Option b: '75m in Treasury notes, 225m in loans, and total assets remain unchanged.' This matches the described transaction: Treasuries fall from 100 to 75 (a 25 decline) and Loans rise from 200 to 225 (a 25 increase), with total assets staying at 350. This is consistent with funding the loan by liquidating Treasuries and preserving asset total. This option is correct.

Option c: '125m in Treasury notes, 200m in loans, and 375m in total assets.' This would imply Treasuries increased by 25 while Loans stayed the same, and total assets increased to 375, which cannot occur when funding a loan commitment by liquidating Treasuries. It also ignores the loan drawdown. Hence, incorrect.

Option d: '100m in Treasury notes, 225m in loans, and 375m in total assets.' Here Treasuries are unchanged at 100, Loans rise to 225 as expected, but total assets would still be 350, not 375. The 375 total assets claim is inconsistent with the balance sheet and the described funding action, so this is incorrect.

In summary, only option b accurately reflects the 25 million liquidated from Treasuries funding a 25 million increase in Loans while keeping total assets unchanged, and all other options misstate the directional changes or the total asset figure.

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