Chapter Seventeen Liquidity Risk

Chapter Outline Introduction Causes of Liquidity Risk Liquidity Risk at Depository Institutions Liability-Side Liquidity Risk Asset-Side Liquidity Risk Measuring a DIs Liquidity Exposure Liquidity Risk, Unexpe ted Deposit Drains, and !ank Runs !ank Runs, t"e Dis ount #indo$, and Deposit Insuran e Liquidity Risk and Life Insurance Companies Liquidity Risk and Property-Casualty Insurers Mutual unds Summary

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Solutions for !nd-of-Chapter "uestions and Pro#lems$ Chapter Seventeen '( )o$ does t"e degree o* liquidity risk di**er *or di**erent types o* *inan ial institutions+ Depository institutions are t"e ,Is -ost exposed to liquidity risk( Mutual *unds, pension *unds, and ./ insuran e o-panies are t"e least exposed( In t"e -iddle are li*e insuran e o-panies( %( #"at are t"e t$o reasons liquidity risk arises+ )o$ does liquidity risk arising *ro- t"e liability side o* t"e balan e s"eet di**er *ro- liquidity risk arising *ro- t"e asset side o* t"e balan e s"eet+ #"at is -eant by *ire-sale pri es+ Liquidity risk o urs be ause o* situations t"at de0elop *ro- e ono-i and *inan ial transa tions t"at are re*le ted on eit"er t"e asset side o* t"e balan e s"eet or t"e liability side o* t"e balan e s"eet o* an ,I( Asset-side risk arises *ro- transa tion t"at result in a trans*er o* as" to so-e ot"er asset, su " as t"e exer ise o* a loan o--it-ent or a line o* redit( Liability-side risk arises *ro- transa tions $"ereby a reditor, depositor, or ot"er lai- "older de-ands as" in ex "ange *or t"e lai-( 1"e $it"dra$al o* *unds *ro- a bank is an exa-ple o* su " a transa tion( A *ire-sale pri e re*ers to t"e pri e o* an asset t"at is less t"an t"e nor-al -arket pri e be ause o* t"e need or desire to sell t"e asset i--ediately under onditions o* *inan ial distress( 2( #"at are ore deposits+ #"at role do ore deposits play in predi ting t"e probability distribution o* net deposit drains+ /ore deposits are t"ose deposits t"at $ill stay $it" t"e bank o0er an extended period o* ti-e( 1"ese deposits are relati0ely stable sour es o* *unds and onsist -ainly o* de-and, sa0ings, and retail ti-e deposits( !e ause o* t"eir stability, a "ig"er le0el o* ore deposits $ill in rease t"e predi tability o* *ore asting net deposit drains *ro- t"e bank( 3( 1"e probability distribution o* t"e net deposit drain o* a DI "as been esti-ated to "a0e a -ean o* % per ent and a standard de0iation o* ' per ent( Is t"is DI in reasing or de reasing in si4e+ Explain( 1"is DI is de reasing in si4e be ause less ore deposits are being added to t"e bank t"an are being $it"dra$n( 5n a0erage, t"e rate o* de rease o* deposits is % per ent( I* t"e distribution is nor-al, $e an state $it" 67 per ent on*iden e t"at t"e rate o* de rease o* deposits $ill be bet$een & per ent and 3 per ent 8plus or -inus t$o standard de0iations9( 7( )o$ is t"e DI:s distribution pattern o* net deposit drains a**e ted by t"e *ollo$ing+ a( 1"e "oliday season( 1"e entire distribution s"i*ts to t"e rig"t 8an in rease in t"e expe ted a-ount o* $it"dra$als9 as indi0iduals spend -ore( Moreo0er, t"e standard de0iation de reases as t"e distribution narro$s(

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b( Su--er 0a ations( 1"e entire distribution s"i*ts to t"e rig"t 8an in rease in t"e expe ted a-ount o* $it"dra$als9 as indi0iduals spend -ore( Moreo0er, t"e standard de0iation de reases as t"e distribution narro$s( ( A se0ere e ono-i re ession( 1"e entire distribution s"i*ts to t"e le*t and -ay "a0e a negati0e -ean 0alue as $it"dra$als a0erage -ore t"an deposits( )o$e0er, as t"e opportunity ost o* "olding -oney de lines, so-e depositors -ay in rease t"eir net deposits( 1"e i-pa t $ill be to $iden t"e distribution( d( Double-digit in*lation( 1"e entire distribution s"i*ts to t"e le*t and -ay "a0e a negati0e -ean 0alue as $it"dra$als a0erage -ore t"an deposits( In*lation -ay ause a general *lig"t *ro- -oney t"at $ill ause t"e distribution to narro$( ;( #"at are t$o $ays a DI an o**set t"e liquidity e**e ts o* a net deposit drain o* *unds+ )o$ do t"e t$o -et"ods di**er+ #"at are t"e operational bene*its and osts o* ea " -et"od+

I* t"e DI "as a net deposit drain, it needs to eit"er in rease its liabilities 8by borro$ing *unds or issuing equity9 or redu e its assets( An institution an redu e its assets by dra$ing do$n on its as" reser0es, selling se urities, or alling ba k 8or not rene$ing9 its loans( It an in rease liabilities by issuing -ore ,ederal *unds, long-ter- debt, or ne$ issues o* equity( I* a DI o**sets t"e drain by in reasing liabilities, t"e si4e o* t"e *ir- re-ains t"e sa-e( )o$e0er, i* it o**sets t"e drain by redu ing its assets, t"e si4e o* t"e *ir- is redu ed( I* it "as a net negati0e deposit drain, t"en it needs to *ollo$ t"e opposite strategy( 1"e operational bene*it o* addressing a net deposit drain is to restore t"e *inan ial stability and "ealt" o* t"e DI( )o$e0er, t"is pro ess does not o-e $it"out osts( 5n t"e asset side, liquidating assets -ay o ur only at *ire-sale pri es t"at $ill result in reali4ed losses o* 0alue, or asset--ix instability( ,urt"er, not rene$ing loans -ay result in t"e loss o* pro*itable relations"ips t"at ould "a0e negati0e a**e ts on pro*itability in t"e *uture( 5n t"e liability side, entering t"e borro$ed *unds -arket nor-ally requires paying -arket interest rates t"at are abo0e t"ose rates t"at it "ad been paying on lo$ interest deposits( <( #"at are t"ree $ays a DI an o**set t"e e**e ts o* asset-side liquidity risk su " as t"e dra$ing do$n o* a loan o--it-ent+

A DI an use eit"er liability -anage-ent or reser0e ad=ust-ent strategies( Liability -anage-ent in0ol0es borro$ing *unds in t"e -oney>pur "ased *unds -arket( Reser0e ad=ust-ents in0ol0e selling as"-type assets, su " as treasury bills, or si-ply redu ing ex ess as" reser0es to t"e -ini-u- le0el required to -eet regulatory i-posed reser0e require-ents(

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A DI $it" t"e *ollo$ing balan e s"eet 8in -illions9 expe ts a net deposit drain o* @'7 -illion( Assets Liabilities and Equity /as" @'& Deposits @;? Loans @7& Equity @< Se urities @'7 1otal Assets @<7 1otal Liabilities A Equity @<7 S"o$ t"e DI:s balan e s"eet i* t"e *ollo$ing onditions o ur( a( 1"e DI pur "ases liabilities to o**set t"is expe ted drain( I* t"e DI pur "ases liabilities, t"en t"e ne$ balan e s"eet isB /as" @'& Deposits @72 Loans @7& .ur "ased liabilities @'7 Se urities @'7 Equity @< b( 1"e stored liquidity -anage-ent -et"od is used to -eet t"e liquidity s"ort*all( I* t"e DI uses reser0e asset ad=ust-ent, a possible balan e s"eet -ay beB Loans @7& Deposits @72 Se urities @'& Equity @< DIs $ill -ost likely use so-e o-bination o* t"ese t$o -et"ods(

6(

AllStar!ank "as t"e *ollo$ing balan e s"eet 8in -illions9B Assets /as" Loans Se urities 1otal Assets @2& @6& @7& @'<& Liabilities and Equity Deposits !orro$ed *unds Equity 1otal Liabilities A Equity @''& @3& @%& @'<&

AllStar!anks largest usto-er de ides to exer ise a @'7 -illion loan o--it-ent( )o$ $ill t"e ne$ balan e s"eet appear i* AllStar uses t"e *ollo$ing liquidity risk strategies+ a( Asset -anage-ent( Assets /as" Loans Se urities 1otal Assets @2& @'&7 @27 @'<& Liabilities and Equity Deposits !orro$ed *unds Equity 1otal Liabilities A Equity @''& @3& @%& @'<&

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b( Liability -anage-ent( Assets /as" Loans Se urities 1otal Assets '&( @2& @'&7 @7& @'?7 Liabilities and Equity Deposits !orro$ed *unds Equity 1otal Liabilities A Equity @''& @77 @%& @'?7

A DI "as assets o* @'& -illion onsisting o* @' -illion in as" and @6 -illion in loans( 1"e DI "as ore deposits o* @; -illion, subordinated debt o* @% -illion, and equity o* @% -illion( In reases in interest rates are expe ted to ause a net drain o* @% -illion in ore deposits o0er t"e year+ a( 1"e a0erage ost o* deposits is ; per ent and t"e a0erage yield on loans is ? per ent( 1"e DI de ides to redu e its loan port*olio to o**set t"is expe ted de line in deposits( #"at $ill be t"e net e**e t on interest in o-e and t"e si4e o* t"e *ir- a*ter t"e i-ple-entation o* t"is strategy+ Assu-ing t"at t"e de rease in loans is o**set by an equal de rease in deposits, t"e ost o* t"e drain C 8&(&? D &(&;9 x @% -illion C @3&,&&&( 1"e a0erage si4e o* t"e *ir- $ill be @? -illion a*ter t"e drain( b( I* t"e interest ost o* issuing ne$ s"ort-ter- debt is expe ted to be <(7 per ent, $"at $ould be t"e e**e t on net interest in o-e o* o**setting t"e expe ted deposit drain $it" an in rease in interest-bearing liabilities+ /ost o* t"e drain C 8&(&<7 D &(&;9 x @% -illion C @2&,&&&( ( #"at $ill be t"e si4e o* t"e DI a*ter t"e drain using t"is strategy+ 1"e a0erage si4e o* t"e *ir- $ill be @'& -illion a*ter t"e drain( d( #"at dyna-i aspe ts o* bank -anage-ent $ould *urt"er support a strategy o* repla ing t"e deposit drain $it" interest-bearing liabilities+ .ur "asing interest-bearing liabilities -ay ost signi*i antly -ore t"an t"e ost rate on deposits t"at are lea0ing t"e bank( )o$e0er, using interest-bearing deposits prote ts t"e bank *ro- de reasing asset si4e or "anging t"e o-position o* t"e asset side o* t"e balan e s"eet(

''( De*ine ea " o* t"e *ollo$ing *our -easures o* liquidity risk( Explain "o$ ea " -easure $ould be i-ple-ented and utili4ed by a DI( a( Sour es and uses o* liquidity(

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1"is state-ent identi*ies t"e total sour es o* liquidity as t"e a-ount o* as"-type assets t"at an be sold $it" little pri e risk and at lo$ ost, t"e a-ount o* *unds it an borro$ in t"e -oney>pur "ased *unds -arket, and any ex ess as" reser0es o0er t"e ne essary reser0e require-ents( 1"e state-ent also identi*ies t"e a-ount o* ea " ategory t"e bank "as utili4ed( 1"e di**eren e is t"e a-ount o* liquidity a0ailable *or t"e bank( 1"is a-ount an be tra ked on a day-to-day basis( b( .eer group ratio o-parisons !anks an easily o-pare t"eir liquidity $it" peer group banks by looking at se0eral easy to al ulate ratios( )ig" le0els o* t"e loan to deposit and borro$ed *unds to total asset ratios $ill identi*y relian e on borro$ed *unds -arkets, $"ile "ea0y a-ounts o* loan o--it-ents to assets -ay re*le t a "ea0y a-ount o* potential liquidity need in t"e *uture( ( Liquidity index( 1"e liquidity index -easures t"e a-ount o* potential losses su**ered by a DI *ro- a *iresale o* assets o-pared to a *air -arket 0alue establis"ed under t"e onditions o* nor-al sale( 1"e lo$er is t"e index, t"e less liquidity t"e DI "as on its balan e s"eet( 1"e index s"ould al$ays be a 0alue bet$een & and '( d( ,inan ing gap and *inan ing require-ent 1"e *inan ing gap an be de*ined as a0erage loans -inus a0erage deposits, or alternati0ely, as negati0e liquid assets plus borro$ed *unds( A negati0e *inan ing gap i-plies t"at t"e bank -ust borro$ *unds or rely on liquid assets to *und t"e bank( 1"us t"e *inan ing require-ent an be expressed as *inan ing gap plus liquid assets( 1"is relations"ip i-plies t"at so-e le0el o* loans and ore deposits as $ell as so-e a-ount o* liquid assets deter-ine t"e need *or t"e bank to borro$ or pur "ase *unds( '%( A DI "as @'& -illion in 1-!ills, a @7 -illion line o* redit to borro$ in t"e repo -arket, and @7 -illion in ex ess as" reser0es 8abo0e reser0e require-ents9 $it" t"e ,ed( 1"e DI urrently "as borro$ed @; -illion in *ed *unds and @% -illion *ro- t"e ,ed dis ount $indo$ to -eet seasonal de-ands( a( #"at is t"e DIs total a0ailable 8sour es o*9 liquidity+ 1"e DIs a0ailable resour es *or liquidity purposes are @'& E @7 E @7 C @%& -illion( b( #"at is t"e DIs urrent total uses o* liquidity+ 1"e DIs urrent use o* liquidity is @; E @% C @? -illion( ( #"at is t"e net liquidity o* t"e DI+ 1"e DIs net liquidity is @'% -illion( %&7

d( #"at on lusions an you deri0e *ro- t"e result+ 1"e net liquidity o* @'% -illion suggests t"at t"e DI an $it"stand unexpe ted $it"dra$als o* @'% -illion $it"out "a0ing to redu e its less liquid assets at *ire-sale pri es( '2( A DI "as t"e *ollo$ing assets in its port*olioB @%& -illion in as" reser0es $it" t"e ,ed, @%& -illion in 1-!ills, @7& -illion in -ortgage loans, and @'& -illion in *ixed assets( I* t"e assets need to be liquidated at s"ort noti e, t"e DI $ill re ei0e only 66 per ent o* t"e *air -arket 0alue o* t"e 1-!ills and 6& per ent o* t"e *air -arket 0alue o* t"e -ortgage loans( Esti-ate t"e liquidity index using t"e abo0e in*or-ation(

i I = wi P * P i i

where wi = weights of the portfolio, Pi = fire-sale prices, Pi* = fair market value of assets

1"us, and assu-ing t"at *ixed assets $ill not be disposed on s"ort noti eB I C 8%&>'&&98'(&&>'(&&9 E 8%&>'&&98&(66>'(&&9 E 87&>'&&98&(6&>'(&&9 E 8'&>'&&98'>'(&&9 C &(?3? '3( /onglo-erate /orporation "as a quired A -e /orporation( 1o "elp *inan e t"e takeo0er, /onglo-erate $ill liquidate t"e o0er*unded portion o* A -es pension *und( 1"e *a e 0alues and urrent and one-year *uture liquidation 0alues o* t"e assets t"at $ill be liquidated are gi0en belo$B Liquidation Falues Asset ,a e Falue tC& tC' I!M sto k @'&,&&& @6,6&& @'&,7&& GE bonds @7,&&& @3,&&& @3,7&& 1reasury se urities @'7,&&& @'2,&&& @'3,&&& /al ulate t"e '-year liquidity index *or t"ese se urities( n i i where wi = weights of the portfolio, * i i Pi = fire-sale prices, Pi* = fair market value of assets

I= w P P

1"us '7(

I C 8&(2229866&&>'&,7&&9 E 8&(';<983,&&>3,7&&9 E 8&(798'2,&&&>'3,&&&9 C &(6%<

.lainbank "as @'& -illion in as" and equi0alents, @2& -illion in loans, and @'7 in ore deposits( %&;

a( /al ulate t"e *inan ing gap( ,inan ing gap C a0erage loans D a0erage deposits C @2& -illion - @'7 -illion C @'7 -illion b( #"at is t"e *inan ing require-ent+ ,inan ing require-ent C *inan ing gap E liquid assets C @'7 -illion E @'& -illion C @%7 ( )o$ an t"e *inan ing gap be used in t"e day-to-day liquidity -anage-ent o* t"e bank+ A rising *inan ing gap on a daily basis o0er a period o* ti-e -ay indi ate *uture liquidity proble-s due to in reased deposit $it"dra$als and>or in reased exer ise o* loan o--it-ents( Sop"isti ated lenders in t"e -oney -arkets -ay be on erned about t"ese trends, and t"ey -ay rea t be i-posing "ig"er risk pre-iu-s *or borro$ed *unds or stri ter redit li-its on t"e a-ount o* *unds lent( ';( )o$ an an ,Is liquidity plan "elp redu e t"e e**e ts o* liquidity s"ortages+ #"at are t"e o-ponents o* a liquidity plan+

A liquidity plan requires *or$ard planning so t"at an opti-al -ix o* *unding an be i-ple-ented to redu e osts and un*oreseen $it"dra$als( In general, a plan ould in orporate t"e *ollo$ingB 8a9 8b9 8 9 8d9 8e9 Assigning a tea- t"at $ill take "arge in t"e e0ent o* a liquidity risis( Identi*ying t"e a ount "olders t"at $ill -ost likely $it"dra$ *unds in t"e e0ent o* a risis( Esti-ating t"e si4e o* t"e run-o**s and t"e sour es o* borro$ing to ste- t"e run-o**s( Establis"ing -axi-u- li-its *or borro$ing by subsidiaries and a**iliates, in luding intera**iliate loans, and t"e -axi-u- risk pre-iu- to be paid during risis borro$ing( Spe i*ying t"e sequen ing o* asset disposal in t"e e0ent o* a risis(

.lanning $ill ensure an orderly pro edure to ste- t"e rus" o* $it"dra$als and a0ert a total breakdo$n during a risis( 1"is is 0ery i-portant *or *ir-s t"at rely on deposits or s"ort-ter*unds as a sour e o* borro$ing be ause o* t"e di**i ulty in rolling o0er debt in periods o* risis( '<( #"at is a bank run+ #"at are so-e possible $it"dra$al s"o ks t"at ould initiate a bank run+ #"at *eature o* t"e de-and deposit ontra t pro0ides deposit $it"dra$al -o-entut"at an result in a bank run+

A bank run is an unexpe ted in rease in deposit $it"dra$als *ro- a bank( !ank runs an be triggered by se0eral e ono-i e0ents in luding 8a9 on erns about sol0en y relati0e to ot"er banks, 8b9 *ailure o* related banks, and 8 9 sudden "anges in in0estor pre*eren es regarding t"e "olding o* nonbank *inan ial assets( 1"e *irst o-e, *irst ser0e 8*ull pay or no pay9 nature o* a %&<

de-and deposit ontra t en ourages priority positions in any line *or pay-ent o* deposit a ounts( 1"us, e0en t"oug" -oney -ay not be needed, usto-ers "a0e in enti0e to $it"dra$ t"eir *unds( '?( 1"e *ollo$ing is t"e balan e s"eet o* an DI in -illionsB Assets /as" Loans .lant and equip-ent 1otal @ % @7& @ 2 @77 Liabilities and Equity De-and deposits @7& Equity 1otal @ 7 @77

1"e asset-liability -anage-ent o--ittee "as esti-ated t"at t"e loans, $"ose a0erage interest rate is ; per ent and $"ose a0erage li*e is 2 years, $ill "a0e to be dis ounted at '& per ent i* t"ey are to be sold in less t"an t$o days( I* t"ey an be sold in 3 days, t"ey $ill "a0e to be dis ounted at ? per ent( I* t"ey an be sold later t"an a $eek, t"e DI $ill re ei0e t"e *ull -arket 0alue( Loans are not a-orti4edH t"at is, prin ipal is paid at -aturity( a( #"at $ill be t"e pri e re ei0ed by t"e DI *or t"e loans i* t"ey "a0e to be sold in t$o days( In *our days+ .ri e o* loan C .FAnC2,kC'&829 E .FnC2, kC'&87&9 C @37(&2 i* sold in t$o days( .ri e o* loan C .FAnC2,kC?829 E .FnC2, kC?87&9 C @3<(3% i* sold in *our days( b( In a risis, i* depositors all de-and pay-ent on t"e *irst day, $"at a-ount $ill t"ey re ei0e+ #"at $ill t"ey re ei0e i* t"ey de-and to be paid $it"in t"e $eek+ Assu-e no deposit insuran e( I* depositors de-and to $it"dra$ all t"eir -oney on t"e *irst day, t"e bank $ill "a0e to dispose o* its loans at *ire-sale pri es o* @37(&2 -illion( #it" its @% -illion in as", it $ill be able to pay depositors on a *irst- o-e basis until @3<(&2 -illion "as been $it"dra$n( 1"e rest $ill "a0e to $ait until liquidation to s"are t"e re-aining pro eeds( Si-ilarly, i* t"e run takes pla e o0er a *i0e-day period, t"e bank -ay "a0e -ore ti-e to dispose o* its assets( 1"is ould generate @3<(3% -illions( #it" its @% -illion in as" it $ould be able to satis*y on a *irst- o-e basis $it"dra$als up to @36(3% -illion( '6( #"at go0ern-ent sa*eguards are in pla e to redu e liquidity risk *or DIs+

Deposit insuran e and t"e dis ount $indo$ bot" "elp in t"e e0ent o* a liquidity drain and bot" "elp to pre0ent liquidity drains *ro- o urring( %&( #"at are t"e le0els o* de*ense against liquidity risk *or a li*e insuran e o-pany+ )o$ does liquidity risk *or a property- asualty insurer di**er *ro- a li*e insuran e o-pany+

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1"e initial de*ense is t"e a-ount o* pre-iu- in o-e and returns on t"e asset port*olio( As additional poli ies are surrendered, t"e insuran e o-pany -ay need to sell so-e o* t"e relati0ely liquid assets su " as go0ern-ent bonds( In t"e ase o* extre-e liquidity pressures, t"e o-pany -ay need to begin to liquidate t"e less-liquid assets in t"e port*olio, possibly at distressed pri es( .roperty- asualty insuran e o0ers s"ort-ter- ontingen ies, and t"us t"e assets o* ./ insurers generally are -ore s"ort-ter- t"an *or li*e insuran e o-panies, and t"e poli y pre-iuad=ust-ents o-e at s"orter inter0als( As a result, alt"oug" t"e degree and ti-ing o* ontingen y payout is -ore un ertain *or ./ o-panies, t"e *lexibility to deal $it" liquidity pressures is better( %'( )o$ is t"e liquidity proble- *a ed by -utual *unds di**erent *ro- t"at *a ed by DIs and insuran e o-panies+ )o$ does t"e liquidity risk o* an open-end -utual *und o-pare $it" t"at o* a losed-end *und+

In t"e ase o* a liquidity risis in banks and insuran e *ir-s, t"ere are in enti0es *or depositors and poli y"olders to $it"dra$ t"eir -oney or as" in t"eir poli ies as early as possible( Late o-ers $ill be penali4ed be ause t"e *inan ial institution -ay be out o* liquid assets( 1"ey $ill "a0e to $ait until t"e institution sells its assets at *ire-sale pri es, resulting in a lo$er payout( In t"e ase o* -utual *unds, t"e net asset 0alue *or all s"are"olders is lo$ered or raised as t"e -arket 0alue o* assets "ange, so t"at e0erybody $ill re ei0e t"e sa-e pri e i* t"ey de ide to $it"dra$ t"eir *unds( )en e, t"e in enti0e to engage in a run is -ini-i4ed( /losed-end *unds are traded dire tly on sto k ex "anges, and t"ere*ore little liquidity risk exists sin e any *und o$ner an sell t"e s"ares on t"e ex "ange( An open-end *und is exposed to -ore risk sin e t"ose s"ares are sold ba k to t"e *und $"i " -ust pro0ide as" to t"e seller( %%( A -utual *und "as t"e *ollo$ing assets in its port*olioB @3& -illion in *ixed-in o-e se urities and @3& -illion in sto ks at urrent -arket 0alues( In t"e e0ent o* a liquidity risis, t"e *und an sell t"e assets at a 6; per ent o* -arket 0alue i* t"ey are disposed o* in % days( 1"e *und $ill re ei0e 6? per ent i* t"e assets are disposed o* in 3 days( 1$o s"are"olders, A and !, o$n 7 per ent and < per ent o* equity 8s"ares9, respe ti0ely( a( Market un ertainty "as aused s"are"olders to sell t"e s"ares ba k to t"e *und( #"at $ill t"e t$o s"are"olders re ei0e i* t"e -utual *und -ust sell all o* t"e assets in t$o days+ In *our days+ Falue o* *ixed-in o-e se urities i* sold in t$o days Falue o* sto ks i* sold in t$o days 1otal @3& x &(6; C @2?(3 @3& x &(6; C @2?(3 @<;(?

S"are"older A $ill re ei0e @<;(? x &(&7 C @2(?3 do$n *ro- t"e urrent 0alue o* @3(&&( S"are"older ! $ill re ei0e @<;(? x &(&< C @7(2<; do$n *ro- t"e urrent 0alue o* @7(;&( Falue o* *ixed-in o-e se urities i* sold in *our days @3& x &(6? C @26(% %&6

Falue o* sto ks i* sold in t$o days 1otal

@3& x &(6? C @26(% @<?(3

S"are"older A $ill re ei0e @<?(3 x &(&7 C @2(6% do$n *ro- t"e urrent 0alue o* @3(&&( S"are"older ! $ill re ei0e @<?(3 x &(&< C @7(3?? do$n *ro- t"e urrent 0alue o* @7(;&( b( )o$ does t"is situation di**er *ro- a bank run+ )o$ "a0e bank regulators -itigated t"e proble- o* bank runs+ 1"is di**ers *ro- a run on a bank in t"at t"e lai-ants o* t"e assets all re ei0e t"e sa-e a-ount, as a per entage o* t"eir in0est-ents( In t"e ase o* bank runs, t"e *irst to $it"dra$ re ei0es t"e *ull a-ount, lea0ing t"e likeli"ood t"at so-e depositors -ay not re ei0e any -oney at all( 5ne $ay o* -itigating t"is proble- is *or regulators to o**er deposit insuran e su " as t"at pro0ided by t"e ,DI/( 1"is redu es t"e in enti0e to engage in runs( %2( A -utual *und "as @' -illion in as" and @6 -illion in0ested in se urities( It urrently "as ' -illion s"ares outstanding( a( #"at is t"e net asset 0alue 8IAF9 o* t"is *und+ IAF C Market 0alue o* s"ares>nu-ber o* s"ares C @'&->'- C @'& per s"are b( Assu-e t"at so-e o* t"e s"are"olders de ide to as" in t"eir s"ares o* t"e *und( )o$ -any s"ares at its urrent IAF an t"e *und take ba k $it"out resorting to a sale o* assets+ At t"e urrent IAF, it an absorb up to @' -illion, or '&&,&&& s"ares( ( As a result o* anti ipated "ea0y $it"dra$als, t"e *und sells '&,&&& s"ares o* I!M sto k urrently 0alued at @3&( Un*ortunately, it re ei0es only @27 per s"are( #"at is t"e net asset 0alue a*ter t"e sale+ #"at are t"e as" assets o* t"e *und a*ter t"e sale+ Its loss by selling '&,&&& s"ares o* I!M at @27 instead o* @3& C -@7 x '&,&&& C -@7&,&&&( Ie$ IAF C @6,67&,&&& >'- C @6(67 /as" C @' -illion E @27&,&&& C @'(27 -illion and 6(;& -illion in se urities( d( Assu-e t"at a*ter t"e sale o* I!M s"ares, '&&,&&& s"ares are sold ba k to t"e *und( #"at is t"e urrent IAF+ Is t"ere a need to sell -ore se urities to -eet t"is rede-ption+ I* '&&,&&& s"ares are redee-ed, it needs to pay @6(67 x '&&,&&& C 667,&&&( Its IAF $ill re-ain t"e sa-e, i(e(, @?,677,&&&>6&&,&&& C @6(67( Io, it does not need to sell any extra s"ares sin e it "as @'(27 -illion in as"(

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