Dialogue

/Read the dialogue in parts.

Board Member: 1 notice lhal our cash and cash-in-banks has

been building up above Ihe amount required

by law.
President: I've had the same thoughts. And right now

there is a new offering of municipal bonds

lhal can be bought at a price lhal will yield

3.5%.
B. M.: Are Ihcy general obligation bonds?

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Yes, they are. 1 prefer those to revenue bonds, don't you?

1 do. Does this issue have an AA rating? Yes. And they can be had in five to ten-year

maturities.

They're lax-exempt, you know. Do you think we might also buy some stocks to keep our portfolio well diversified? Well, we might. But stocks arc much more

speculative.

Unless we slick to blue chip issue. They show

less price fluctuation.

Questions on the dialogue:

1. What problem is being considered by the President and the

Board Member?

2. How can the bank invest ils funds profitably at present?

3. Why does the President prefer to invesl in general obliga-

lion bonds?

4. What does the Presidenl know aboul a new offering of
municipal bonds?

5. Where else can Ihey invesl the bank's funds?

6. Whal sort of stocks are they going lo invesl in and why?

Text

The investment policy of a bank is based upon the recon­ciliation of two conflicting aims. On Ihe one hand the bank wants to make as much profit as it can and for this reason it must lake the risks of lending money. On Ihe other hand its funds belong to its depositors and must be available when­ever they wish to make withdrawals.

There are Iwo Ihings that Ihe bank must therefore do. First, il must keep a proportion of its asscls in the form of

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rash lo meel demands. The amount thai Ihis needs lo be varies very lillle from one bank lo another or from one day lo another and experience suggesls thai il is aboul six percent. As a cushion against unexpected demands a further propor­tion of funds is invested at low rates of return in highly liquid lending mostly to firms in the money and capital markets.

The second thing that Ihe bank must do is trf ensure lhal the inveslmcnls il chooses are sale. This also means lhal Ihcy are relalively low yielding since high yields are associaled wilh risk and wilh lending tor long periods of lime. Much of abank's investment is in short and medium lenn government and lo­cal government bonds. They yield certain incomes and are readily saleable should Ihe occasion demand.

Advances by a bank lo ils customers are the least liquid of Ihcir assels since Ihere are few borrowers who could repay a loan al very shorl notice. However, Ihey are also the most profitable of Ihem yielding Ihe highest rale of return. Advances lo customers arc likely to account for more than two thirds of Ihe banks investment portfolio although Ihis will vary on a day lo day basis since overdrafts arc Ihe most common form of advance and are not immediately controllable by Ihe bank. In general banks do nol lend lo industry for long periods of lime or for inveslmenl projccls. They regard Ihemselves as providing working capital rather than fixed capital.

Questions on the text:

1. What Iwo conflicting aims musl a bank reconcile in ils in-

vestmenl policy?

2. What must the bank do lo be ready lo meel demand for
cash on the part of its customers?

3. Why does Ihe bank prefer ralhcr low yielding inveslmcnls?

4. Which inveslmcnts do visually yield high returns?

5. Which investmenls arc hardly conlrollable by Ihe bank?

Why?

6. Why don't banks usually invesl in indvislrial projecls?

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